5. The Statement of Retained Earnings

Let's talk about the statement of retained earnings. It's a long one. Okay, so we touched briefly on this when we were looking at shareholders' equity, 'cause if you'll recall, let me just do this over to the side. Owners' equity is retained earnings plus capital stock, capital, paid-in capital, whatever. So this is what we're talking about right here. So we've already looked at this briefly, but let's do it again for fun. Now, words have meaning, so let's take these words together. Retained, kept, held on to, still have. Let's just say retained is the same word as kept. Okay? So why is it called the statement of retained earnings?

Well, it's the statement of how much earnings we kept. Let's take a look at what this statement actually says. So the statement says beginning retained earnings balance. It's just carried over from last year. When the company starts, it's gonna be zero 'cause there is no beginning balance. Plus net income minus dividends equals, bingo, end retained earnings.

So what makes this retained earnings? I went on and on up here about how retained earnings means earnings we kept, and then I just threw this formula at you. Fair enough. Understood. So let's see if we can logic our way into it. So we wanna find out how much earnings we kept, right? So that means we should start with earnings.

So if we wanna find out how much earnings we kept, we have to start with earnings, and then we give some away. And that gives us the earnings that we kept 'cause if we gave some away, we did not keep them. I know, rocket science. So then that becomes net income.

Net income is our earnings. Well, which ones did we give away? Well, dividends. We paid out dividends. Then what we have left over is earnings kept equals retained earnings. So this is not some fancy accounting buzzword. This is actually quite simple and quite stupid. It is the earnings that we've retained, and they swapped it to make it look cooler. I don't know. It could go either way. Retained earnings, earnings retained. Doesn't matter.

So when you see the statement of retained earnings, you need to think to yourself, "Well, which earnings did I retain? Well, I know what earnings are. I know that earnings are net income. That's pretty simple. Net income is revenue minus expenses equals net income. That makes sense. That makes sense that that's my earnings. Now, which earnings did I keep? Well, I started with all of my earnings, and I gave some of them away, so my retained earnings is what I didn't give away." Simple enough. What's this nonsense here about beginning retained earnings and ending retained earnings?

Good question. So the retained earnings statement represents a change over a period of time. So let's say that the beginning retained earnings balance is 1,000. Well, where did that 1,000 come from? So if we're saying beginning retained earnings balance is 1,000, well, that was just the year before's ending retained balance, or ending retained earnings balance.

So let's say this is 2000, this is 2001, 2002. So then you had 100 in net income, 10 in dividends, right? So you end up with 1,090. Then you carry this up to the next year, 1,090, and you go through it again. You come out with something, and it just keeps going. So that's what this beginning stuff is all about. And like I said, if it's the first year in business, let's say 2000 is the first year in business, well, you don't have any beginning retained earnings because this is your first year of operating.

Then from years after that, you take your ending from one year and make it your beginning of the next year. And because we know that net income is representative of a period of time, then the statement of retained earnings represents the change, the delta. We'll just say change. Triangle means change. The change over a period of time.