The term accumulated earning refers to a company’s net profits after the payments of dividends have been made. This term is often used interchangeably with others such as; accumulated profits, retained earnings, earned surplus or income reserve, but they are all meant to convey the same idea.
With this income reserve, the management of a business can either put it away for future use or reinvest it back into the business.
A couple of ideas for reinvestment include the following:
A business expansion includes; increasing the workforce, venturing into new markets, new locations and other decisions like that.
Channelling more funds into advertising, introducing new product lines or increasing the manufacturing target of existing products.
Conducting extensive research on the target market and seeking out growth opportunities.
Forming business relationships that would move the company forward, either in the form of a merger, an acquisition or a partnership.
Settling all outstanding loans and debts.
The decision for reinvestment should be decided either by the shareholders of the company or its management. A situation where a managerial decision is not favorable to the shareholders can be ruled out with a majority vote.
Why give attention to your business’ accumulated earnings?
When you pay attention to your business’ accumulated earnings, you can determine at a glance how well your company or business is doing financially. You get to see the total amount of revenue generated and invested by your company over a specific duration of time.
Without it, you might be left in the dark about your business's financial situation, as revenue and earnings are not always constant and are given to fluctuations.
Therefore, if you want to see substantial growth or progress with your business, you must decide to get updated with your accumulated earnings from time to time. Knowledge of this will help you make the following necessary business decisions, whether to make some investments for a new arm of the business, for recent locations, for expansion or to stay ahead of the competition.
Stakeholders and investors also take a keen interest in a business’ accumulated earnings. They want to know how their investments are faring and determine how credible the business is financial.
Calculating your accumulated earnings
To know what your business accumulated earnings are, make use of this formula:
Accumulated Earnings = Accumulated Profit Beginning of the Year - Cash Dividends - Stock Dividends
You can pay dividends either in cash or with stocks. Whichever payment method you opt for, it still needs to be taken out from your gross earnings for the year. That is why each of these methods is included in the formula.
To better illustrate: if Company XYZ had an accumulated earning of a million dollars at the beginning of the year, and it sustained a loss of a fifty thousand dollars, and then paid out dividends amounting to two hundred thousand dollars, then its accumulated earnings can be calculated as follows:
$1,000,000 – $50,000 - $200,000 = $750,000.
Hence, the company’s new accumulated earnings would be $750,000.
This figure is then used to begin a new accounting year and can be used either for reinvestments or put aside for future purposes.
Why is it important to be aware of your business’ accumulated earnings?
The concept of accumulated earnings is not necessarily meant to depict leftover funds after payments of dividends have been made. Instead, it is intended to present an overview of how well a company has been faring and what it is doing with its finances, whether profits are being channeled back into business expansion or for the acquisition of assets.
More importantly, it can be used to evaluate which aspect of the business is doing well compared to its past performance or other business areas.
A company’s accumulated earnings can also reflect its dividend policy because it will reveal its priority in either paying dividends or reinvesting.
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