Retained earnings tell you what stayed in equity

“We retained the profit” does not mean the company placed the same amount in a separate bank account. Retained earnings belongs in equity. The resources supported by the company's financing can be held in cash, inventory, equipment or other assets.

The OpenStax retained-earnings explanation distinguishes earned capital from capital contributed by shareholders. Its retained-earnings account follows cumulative income, losses and declared dividends. Follow that account separately from the cash statement.

Roll the earned balance forward

An invented corporation opens a year with $60,000 retained earnings. It records $24,000 net income after every expense and tax, and declares and pays $9,000 cash dividends. There are no other retained-earnings adjustments, stock dividends or corrections.

The closing balance is $60,000 + $24,000 − $9,000 = $75,000. Retained earnings rose $15,000. The calculation explains that equity account; it contains no requirement for cash to rise by $15,000.

Make a separate cash bridge

Supply the same corporation's complete cash record. It begins with $18,000. Net operating cash for the year is $24,000, matching net income only because this simplified case explicitly supplies that equality. A new loan brings in $30,000 before the corporation pays $42,000 for equipment. It also pays the $9,000 dividend already described.

Closing cash is $18,000 + $24,000 + $30,000 − $42,000 − $9,000 = $21,000. The cash increase is $3,000; the retained-earnings increase is $15,000. Each is consistent with the supplied transactions.

The equipment purchase is recorded as an asset acquisition. Any expense for using equipment during this year is already included in the supplied net income. Do not deduct another charge merely to force the balances to match. The loan creates cash and debt, not additional profit.

Change financing without changing earnings

In a separate version, shareholders pay the corporation $30,000 for newly issued shares instead of the corporation borrowing it. Keep the other transactions unchanged. Cash still closes at $21,000, and retained earnings still closes at $75,000. Contributed capital rises instead of debt.

That distinction prevents a new investment from being described as money the business earned. If the investor instead buys an owner's existing shares, the destination of the money changes again. The company-versus-owner comparison follows that case.

Return to the spending decision

A proposed payment needs available cash, reliable incoming receipts and the obligations already attached to them. An actual distribution also requires attention to governing rules and agreements. A retained-earnings balance alone establishes neither funding nor permission.

Put the two closing balances beside each other: $75,000 accumulated retained earnings and $21,000 cash under these assumptions. For a founder's account of ownership and continuing commitments, read the opening of Infinite Upside.