Monday, 29 Aug 2022
Small business owners and young entrepreneurs in Melbourne who have recently launched their start-ups often feel confused when it comes to accounting jargon. These terms are challenging to understand without the assistance of a professional bookkeeper in Melbourne.
A slight misunderstanding can lead to difficulty analysing financial data and making bad decisions based on half-baked information. Thus, it is essential to have a fair knowledge of these concepts that are an integral part of the financial reports. Among these terms, retained earnings are often confused with net profit.
Although both the terms are relevant for determining the financial health of the business, they differ from each other. Let us help you clear all your doubts regarding net profit and retained earnings.
Retained earnings are the accumulated profits of the business after deducting all the dividends paid to the shareholders. It includes the profits made over the years that are not distributed and can be used for reinvestment into the business for expansion and growth. Thus, bookkeepers suggest using retained earnings to purchase equipment or pay off business debts.
The business owner can find the retained earnings of the business in the equity section of the balance sheet. Some bookkeepers prefer to prepare monthly retained earnings statements for the management to track changes in the amount and to identify the factors affecting it. The formula for retained earnings is:
Initial Retained Earnings (from previous reporting period) + Net Profit – Dividends
Let us assume a growing business has sold some stocks to stakeholders and needs to calculate its retained earnings. Suppose the initial retained earnings were $1,000, and its current profit is $50,000. Also, the business has to pay $10,000 as dividends. Thus, the retained earnings will be: $1,000 + $50,000 – $10,000 = $41,000.
If the business does not pay dividends, it will be left with $51,000, which can be kept as a reserve by the bookkeeper. Note that in the case of a start-up, the beginning retained earnings will always be zero.
Bookkeepers provide the business owner with the details of retained earnings in Melbourne because it helps them to understand whether they have the financial capacity to pay dividends to shareholders or not. If the net profit is low, they can keep it reserved and pay the dividends later.
Conversely, if they make a significant profit and have substantial beginning retained earnings, they can pay off the dividends and use the capital for reinvestment into the business.
Moneylenders and angel investors in Melbourne also look at the retained earnings of the business before investing in it because it gives them an insight into the financial health of the entity.
Net profit, also known as net income, is calculated by deducting the business expenses from its earnings. Suppose income generated by a business in Melbourne stands at $50,000 and its expenses are $40,000, then the net profit is $10,000.
If there is any change in the business’s net profit, the retained earnings also get altered. For example, if the net profit increases, the retained earnings will increase and vice versa. Higher retained earnings mean the business is performing well and generating exceptional profits, while a low number indicates deficit and loss.
Net profits are affected by the costs and sale of goods. Similarly, dividends can also impact retained earnings. Payments of cash or stock dividends can bring down the amount of retained earnings for the business in Melbourne. Thus, bookkeepers keep things balanced with their reporting and financial advice.
Although retained earnings are related to the net profit, they are not the same. According to the formula for retained earnings, net profit impacts retained earnings. However, these two can be different for the business. For example, a company in Melbourne may have a positive net profit.
Still, the retained earnings can be negative because you need to pay dividends, which can be higher in number than the profit generated. Let us assume that the net profit of a business in Melbourne is $20,000, and it does not have any beginning retained earnings. However, it must pay $5,000 each to five of its shareholders. Thus, the retained earnings will be:
$0 + $20,000 – $25,000 = – $5,000
Some people confuse retained earnings with shareholder’s equity. However, shareholder’s equity is calculated by deducting total liabilities from total assets. Retained earnings are only a part of the total assets. Thus, retained earnings offer a more profound insight into the business’s financial stability.
Your bookkeeper in Melbourne is the best judge for efficiently utilising business capital. It helps to retain the capital in the business instead of distribution. So, when they ascertain that the retained earnings can be negative for the business despite making profits, they stop payments to shareholders.
Also, if the business is not making any profits, the beginning retained earnings can be utilised to stay afloat. The bookkeepers use retained earnings for reinvestment when both are positive, and the business needs capital for growth.
Business owners need to stay updated about the business’s financial status to make informed decisions related to reinvestment and growth. Thus, they must have a clear idea of the elements that best describe this status and adhere to the suggestions of the bookkeeper.
