Definition
Retained earnings are the profits a company has built up since it started, after Corporation Tax, less all the dividends it has paid. They sit within capital and reserves on the balance sheet, often on a line labelled “profit and loss account”. For most small companies, retained earnings are the starting point for checking whether there is enough profit to pay a dividend.
Retained earnings and dividends
Company law allows dividends only out of profits available for distribution: accumulated realised profits less accumulated realised losses. A dividend paid beyond that is unlawful. A shareholder who knew, or had reasonable grounds to believe, that it was unlawful must repay it. The consequences are covered in more detail in what happens when dividends exceed profits.
Example
ABC Trading Ltd made after-tax profits of £40,000 in its first year and £30,000 in its second, and paid dividends of £50,000 in total. Its retained earnings at the end of year two are £20,000.
Retained earnings are not cash
Retained profits can be tied up in equipment, stock or money owed by customers. A company can show healthy retained earnings and still have little in the bank. For how the figure sits beside share capital, see capital and reserves explained.
Related questions
- How do I pay myself a dividend legally? Confirm there are enough distributable profits, then have the directors declare the dividend and record it; the steps are in the guide to paying yourself a dividend legally.
- What happens if I take dividends when the company hasn't made enough profit? The dividend is unlawful, and a shareholder who knew, or should have known, may have to repay it.
Related terms
-
Unlawful dividend
An unlawful dividend (often called an illegal dividend) is a dividend a limited company pays when it does not have enough profits available for distribution to cover it.
Read definition -
Balance sheet
A balance sheet is a snapshot of a company's finances on the last day of its financial year.
Read definition -
Share capital
Share capital is the amount shareholders have paid, or agreed to pay, a company for their shares, recorded at the shares' nominal (face) value.
Read definition
