Statement of Retained Earnings

A Statement of Retained Earnings is sometimes called statement of changes in financial position, statement of owner's equity, equity statement or statement of shareholders' equity. The latter appears to be a more accurate term, because this statement deals exclusively with changes in shareholders’ equity over a certain period of time – annual, semiannual or quarterly.

Retained earnings refers to the portion of net income of a corporation that is retained by the corporation (and thus increase the book value of shareholders’ equity) rather than distributed to shareholders as dividends.

Table. Statement of Retained Earnings Example

The only interesting item for financial analysis on this statement (which is usually prepared on the same sheet with your P&L) is dividends. And even that is not remarkable at all given that dividends show up on your cash flow statement which is far more interesting and valuable for financial analysis.

The main problem with the Statement of Retained Earnings is that it is, to tell the truth, quite a bit misleading. It essentially shows which part of net income goes to shareholders – in the form of dividends – and which part stays in the company (is reinvested as retained earnings).

The problem is that you net income is an accrued – ‘paper’ profit that can not be used for any kind of payment, including dividends. Dividends are paid from operational cash flow which can be very different from your net income, depending mostly on how well you manage your working capital.

Besides, the Retained Earnings item on your balance sheet is virtually useless. Why? Because it is used to determine the so-called book value of your shareholders’ equity that has absolutely nothing to do with its real – intrinsic – value calculated using financial valuation model for your whole business entity.

Which means that for the purposes of financial analysis, your statement of retained earnings is also essentially useless.