Retained Profit: Definition, Functions, and Factors

Retained Profit – Business people are certainly familiar with the term profit which is the goal when running a business. Not all profits will go into the pockets of entrepreneurs and shareholders. Profits are also retained for various reasons, for example for business development.

Retained earnings can be found on a company’s balance sheet and is at the bottom of shareholder equity at the end of each accounting period. This is because retained earnings are still profits owned by the company, although not directly.

So, what is the meaning of retained earnings? What are the characteristics of retained earnings? Then what is the relationship between retained earnings and dividends? How to calculate retained earnings?

Definition of Retained Profit

Retained profit is a part of net profit that is retained and the company does not pay out to investors in the form of dividends whose purpose is as a precautionary fund, additional reserve capital, as well as the company’s investment needs. Retained profit, usually referred to as retained earnings . In short, retained earnings can also mean the remaining net profit that has been reduced by dividends. Dividends are distributions of profits by businesses to shareholders in equal or proportionate proportion to their shareholdings.

This retained earnings decision can occur based on a joint decision at the General Meeting of Shareholders (GMS). Decision making can occur due to various factors, namely based on the financial condition of the business, its marketing strategy, and operational funding requirements for the coming period.

The effect of rising or falling profitability also occurs due to various factors, such as changes in corporate taxes, changes in selling costs, changes in production costs, changes in the cost of goods, changes in net income, changes in the amount of dividends that companies must pay to shareholders, and changes in administrative costs.

Profit Retention Function

1. Help pay the company’s debts

Companies can increase profits by holding profits for a relatively long period of time if the company has a significant amount of debt. Because by utilizing the rest of the profits, company accountants can make debt payments on time. In addition, in paying off its debts, the company will not interfere with other sources of funding so that the company can ensure the safety of its main funds.

2. To finance the company’s operations

A business must have sufficient funds to operate, including petty cash and large cash. Companies can retain profits to finance the company’s operations. The company does this to provide the possibility that the company can continue to operate and have the hope of continuing to grow.

3. As a reserve capital

Another advantage of retaining profits is that the funds from profits have a function as a capital reserve if the business experiences financial difficulties. The use of reserve funds is to increase funds so that businesses can continue to operate effectively without having to borrow money from third parties such as banks.

See also  Understanding the Definition of Identity and Tips for Finding Identity

4. For business development

Besides having a function as a source of reserve funds when the company’s finances are experiencing a loss. The function of retaining profits is that it can also be used as capital for business development. This business development is not limited to development, but can also include adding human resources to the company.

5. The company’s investment capital in the future

Of course, business owners want a business that is not static or even relatively declining, but wants growth and innovation to survive and develop. Another advantage of holding profits is to expand the business or make investments.

Factors Of Retained Profit

There are several factors that contribute to retained earnings, including the following:

1. There is a change in company management

If the management or control of the company changes, existing profits will generally be maintained. The new management made changes with the aim of enabling them to adapt and show credibility to their financial management.

2. There were errors in the financial statements of the previous period

Another factor is the occurrence of errors in the financial statements in the previous period. The company improves the financial statements to obtain validation and calculates the value of retained earnings reports accordingly.

3. There is an adjustment in the value of the rupiah from the previous period

Adjustment of the rupiah value is also an influential factor in determining retained earnings. The rupiah exchange rate can fluctuate at any time and can affect the results of calculating company profits. Thus, accountants have the option to maintain existing profits.

4. There is a change in the calculation method

The factor of changing the calculation method also contributes to retained earnings. For example, if the previous calculation method was always monthly and then switched to weekly, it would be confusing. Accountants have the option to retain existing capital gains because the data they have is ambiguous.

5. Changes in accounting principles from the previous period

Changing accounting principles since the previous period can also affect the value of retained earnings. For example, when the next period businesses start adopting sharia accounting, bookkeeping along with the results is mandatory for implementing sharia law.

Characteristics of Retained Profit

The characteristics of retained earnings, according to the definition, have not been calculated to be divided into various sectors that have the right to receive funds, such as investors or shareholders. Several factors become the background for retained earnings, among others:

1. There were errors in the financial statements in the previous period

Profits can be retained when the accountant has not been able to provide valid data. To avoid fraud and losses in profit sharing, the distribution will be stopped until the financial statements are correct or appropriate.

2. Changes in calculation methods

Changes in calculation methods are often the reason for retained earnings. For example, the previous calculation method always applied the monthly system and then changed it to daily.

3. Changes in accounting principles from the previous period

Changes in accounting principles from the previous period can affect retained earnings. For example, changes in calculation methods, financial reporting models prepared and accounting schemes.

4. There is a change in company management control holders

Withholding profits in this case was carried out in order to maintain work stability, suppress acts of suspicion and fraud. This is done so that the new management can adapt and show the credibility of its management to manage finances.

5. There is an adjustment in the value of the rupiah from the previous period

The rupiah exchange rate can go up and down at any time. If the change in the exchange rate significantly affects the results of calculating the company’s profit, the accountant generally decides to retain existing profits.

See also  Mutations: Definition, Causes, Types, Benefits and Disadvantages of Mutations

The Link between Retained Profit and Dividend

Retained earnings have a strong relationship with dividends. Dividends are rights owned by shareholders for the profits generated by the company. The actual retained earnings are the property of the shareholders which are still held by the company for business expansion purposes. When the retained earnings are finally decided to be distributed to shareholders, then it is called dividend distribution.

Dividend distribution is based on the number of shares owned by each shareholder. This dividend distribution policy varies from time to time according to the circumstances and conditions of the company.

If the company sees good prospects in the future, some of the profits will be retained by the company in the form of retained earnings with the aim of increasing its capital requirements and financing most of its own needs.

How to Calculate and Make a Retained Profit Report

Retaining earnings is one of the most important financial statements for a company and requires regular preparation. The ability of a business to operate effectively and achieve its business objectives is highly dependent on the quality of this report.

We must calculate how much profit is retained by the company, here are the ways and steps to calculate profit:

Step 1: Calculating gross profit

The first component of calculating profit is the gross profit or business profit obtained from sales, namely in the profit formula as follows:


Step 2: Calculating operating profit

If Sinaumed’s has obtained the amount of gross profit, the next step is to calculate the company’s operating profit using the following profit formula:


Step 3: Calculating net profit before taxes

Calculating net profit before tax is the next step to determine retained earnings. This is calculated by deducting interest, amortization, and depreciation from operating profit. The following is the net profit formula.


Step 4: Calculate taxable net income

The way to calculate net profit after tax can be Sinaumed’s using the following profit formula:


Step 5: Calculating retained earnings

After Sinaumed’s knows the company’s net profit in a certain period, Sinaumed’s can calculate the company’s retained earnings by using the following formula:


Example of Retained Earning Report

In the retained earnings report , there are 3 examples that can be used by companies:

1. Example of a Separate Retained Earnings Report

In this report, the initial balance of retained earnings is reported and then added to net income or reduced by net loss.

Then, the result is reduced by dividends to obtain the ending balance for the period.

An example of a separate retained earnings statement is as follows:

2. Sample Report of Retained Earnings Compiled with a Report on Shareholders’ Equity

Any change in shareholder equity must be reported during the period.

If changes only occur in net income, net loss, and dividends, then it is enough for the company to make a retained earnings report .

However, if there are changes in shares and other paid-in capital accounts, the company must prepare them in the shareholders’ equity statements

Below is an example of retained earnings on a statement of shareholders’ equity.

3. Merged with the Profit and Loss Report

In addition to the two previous formats, the retained earnings report can be combined with the income statement.

One of the advantages of using this presentation format is that it can emphasize net income as an intermediary for the income statement with the retained earnings portion of shareholder equity.

Conclusion of Retained Profit

The way to calculate retained earnings is of course different for each company. This is due to differences in the amount of dividends that have been agreed upon by the commissioners or different types of companies. When all of these calculations have been fulfilled, the remaining amount of retained earnings can return to the company as an investment for the next quarter.

However, this retained profit can also be allocated for other things according to the agreement of the company’s commissioners. Retained earnings are also possible to have a minus value because the company is experiencing losses when compared to the previous year. Because the loss is greater than the total, this is what allows a minus to the total retained earnings .

Also read:

  • Several Factors Causing Economic Problems in Indonesia
  • Understanding Green Economy: Origins, Goals, Principles
  • Economic Principles: Definition, Characteristics, and Examples
  • Economic Measures: Definition, Types, & Relationships
  • Economic Goods: Definition, Types, and Examples