How does net income affect retained earnings?
What is Net Income
Net income is the amount that remains after the deduction of total expenses from the company’s total revenue. This is the amount of money that the company has left over after it has paid all of its expenses. The net income can be used to pay dividends to shareholders, reinvest in the company, or pay down debt.
Net income, also known as net profit or bottom line, is the total revenue earned from sales minus the cost of goods sold, operating expenses, and taxes. In other words, it’s the amount of money that a company has left over after all its expenses have been paid.
The term “net income” can be used to describe the amount of money that a company has earned in a given period of time, such as a year or a quarter. It can also be used to describe the amount of money that a company’s shareholders have earned because they own the company and are entitled to its profits.
Net income is an important metric for investors because it shows how much money a company is actually making. It is also a good way to compare different companies because it takes into account all of the expenses and revenues that each company has.
Net income is the bottom line of the income statement. It is a positive figure which means the revenue is greater than the total expenses. It is the connection between the income statement and the balance sheet. The result of the income statement will be the net income or net loss. Net income will increase the retained earnings while the net loss will reduce the retained earnings.
Retained Earnings
Retained earnings are the accumulated profit or loss of the company from the beginning up to the reporting date.
Retained earnings are the equity component which presents on the balance sheet. It also presents the statement of change in equity.
The positive retained earnings are the total profit that remain after the dividend is paid to the owner. The management team can use the retained earnings to allocate the dividend to all owners. Moreover, they can use it to reinvest into the business by purchasing new fixed assets to expand operation and invest in new products.
Impact of Net Income on Retained Earnings
At the beginning of the business, the retained earnings started from zero. If the company is making a loss, it will reduce the retained earnings to a negative balance. The net loss will keep increasing the retained earnings to a negative balance.
On the other hand, the company’s net income will increase the retained earnings balance. The excess revenue over expenses will be transferred from the income statement to the balance sheet.
The net income will increase the retained earning on the balance sheet. The net income will keep increasing the retained earning balance.
Other Factors Impact Retained Earning
- Dividend Paid: The company may decide to withdraw the profit and share with the owners. Each owner will receive the dividend amount base on the ownership of the company. The total dividend paid will reduce the retained earnings balance of the company. The dividend entry will reduce the cash balance and retained earning balance.
- Adjustment of the prior year: After the year-end, the company has to prepare the income statement and balance sheet. All income and expenses will be reset to zero at the end of the year. The result of the income statement will be carried forward to the balance sheet. If the company found some mistake related to the expense or income accounts of the prior years, they cannot go back to revise the income statement. However, they can adjust with the retained earning on the balance sheet.
