Net Profit and Retained Earnings: What’s the Difference?

You’ve probably seen these two terms on your monthly profit & loss statements. Maybe you’re not sure what they mean, how they’re different — and if it matters.

Here’s a quick overview to help you better understand the financial performance of your business.

 

Net Profit

Also called Net Income on some P&L statements, this number is the money you have left after you’ve paid your expenses. For example:

    $70,000 Revenue

$60,000 Expenses

= $10,000 Net Profit

 

Revenue is the money you receive from selling products or services to your customers.

Expenses are everything businesses pay to keep operating, such as:

  • Cost of goods sold
  • Rent & utilities
  • Employee payroll
  • Office supplies
  • Bank fees & loan interest
  • Insurance premiums
  • Repairs & maintenance
  • Advertising & marketing
  • Legal & professional fees
  • Taxes
  • Depreciation

 

Retained Earnings

Sometimes called member capital, this is what’s left from your net profits after you pay out dividends to shareholders. It also includes your retained earnings to date.

Shareholders are investors who own stock or equity in your business.

Dividends are a company’s distribution of revenue back to the shareholders. Sometimes they are paid as a cash dividend, of companies may offer a dividend reinvestment program (DRIP) for shareholders to reinvest the dividends back into company stock, usually at a discount.

 

The formula for calculating retained earnings is:

Beginning retained earnings + net profit – dividends = current retained earnings

 

In the following example, we assume you have $10,000 in net profit and a total of $2,000 in dividends paid to shareholders:

 $1,000 Beginning Retained Earnings

+ $10,000 Net Profit

  $2,000 Dividends

=   $9,000 Retained Earnings as of the end of this statement period

 

If you don’t have any shareholders, your calculation would look like this:

      $1,000 Beginning Retained Earnings

+ $10,000 Net Profit

          $0 Dividends

= $11,000 Retained Earnings as of the end of this statement period

 

Net Losses

Unfortunately there is a possibility that your expenses exceeded your revenues, or that you made a net profit but it was offset by dividends payouts. For some businesses — such as those with seasonal revenue fluctuations or have just made a large capital purchase — this is normal. For others, it’s a red flag.

 

This is how retained earnings reflecting a loss would look on your profit & loss statement:

       $500 Beginning Retained Earnings

+ $1,000 Net Profit

$2,000 Dividends

=  –$500 Retained Earnings as of the end of this statement period

 

Why Retained Earnings Matters

Since this number is a running total of your retained earnings for the year to date, lenders and investors will consider it even more important than net profit when deciding whether to trust you with their money. It gives a clearer picture of your business than just looking at monthly net profit figures, which can vary quite a lot depending on a wide range of factors.

 

Retained earnings also serve as an indicator of where to put that money.

  • If the number is low, it would be better to keep the money in the business as a cushion against cash flow problems, rather than handing it out as dividends.
  • If both net profit and retained earnings are substantial, it’s time to invest in growing your business, perhaps with new equipment or facilities.

 

Want to learn more about your monthly profit & loss statement? Check out this quick guide:

Understanding Your Profit & Loss Statement

Knowing your financials is essential to business success. Xendoo puts those key numbers at your fingertips with our exclusive app that you can access from anywhere, anytime. Plus, our CPA team will help you understand what the numbers mean, so your small business can keep moving in the right direction.

 

 

This post is intended to be used for informational purposes only and does not constitute as legal, business, or tax advice. Please consult your attorney, business advisor, or tax advisor with respect to matters referenced in our content. Xendoo assumes no liability for any actions taken in reliance upon the information contained herein.

 

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