As a result, any items that drive net income higher or push it lower will ultimately affect retained earnings. Retained earnings are reported under the shareholder equity section of the balance sheet while the statement of retained earnings outlines the changes in RE during the period. Negative retained earnings appear as a debit balance in the retained earnings account, rather than the credit balance that normally appears for a profitable company. On the company’s balance sheet, negative retained earnings are usually described in a separate line item as an Accumulated Deficit.
Here, we’ll focus on what negative retained earnings mean and what they indicate for the success of your business. Cash payment of dividends leads to cash outflow and is recorded in the books and accounts as net reductions. As the company loses ownership of its liquid assets in the form of cash dividends, it reduces the company’s asset value on the balance sheet, thereby impacting RE. The company’s retained earnings calculation is laid out nicely in its consolidated statements of shareowners’ equity statement. Here we can see the beginning balance of its retained earnings (shown as reinvested earnings), the net income for the period, and the dividends distributed to shareholders in the period. They can be cash or stock, and both will reduce retained earnings in different ways.
Always remember that GAAP net income is subject to many non-cash adjustments, where operating cash flow is a fact. Last week we discussed the statement of retained bookkeeping for startups earnings, which is made up contents of this statement and retained earnings. Get instant access to video lessons taught by experienced investment bankers.
Negative retained earnings could result in negative shareholders’ equity if the company has sustained losses for an extended period. Some very public, large companies have negative retained earnings, such as, most recently, Starbucks. The problem with shareholder equity on the balance sheet is that there is no distinction between the capital the owners put into the business and the capital the business produced and retained.
How to prepare a statement of retained earnings?
For those companies at the bottom of the S/E survey, the shareholders received significantly less than the earnings. For example, the average five-year investor in General Electric or General Motors got only about half as much enrichment as those companies earned. Their shareholders would have been richer if they had just received all the companies’ earnings in dividend checks. The same holds true to lesser degrees for the next 20 best performing companies. For a few in the middle of Exhibit I—Pfizer, Phillips, Sun, Chevron, and Caterpillar—shareholder enrichment closely approximated earnings. Whether through dividends or market valuations, investors in these companies did receive the profits, about 100¢ for each $1 of reported net income.