Retained profit is by some way the most important and significant source of finance for an established profitable business.
The principle is simple. When a business makes a net profit, the owners have a choice: either extract it from the business by way of dividend, or reinvest it by leaving profits in the business.
Where do retained profits sit? Some might be in the bank; some might be spent on additional plant & machinery; perhaps some are reinvested in more inventories or used to reduce overdrafts or loans.
The total value of retained profits in a company can be seen in the "equity" section of the balance sheet.
Retained profits have several major advantages:
Are there any downsides to using retained profits as a source of finance?
Directors of quoted companies occasionally get criticised for restricting the value of dividends and for hoarding too much cash in the business. If retained profits don't result in higher profits then there is an argument that shareholders could make better returns by having the cash for themselves.
Join the tutor2u Business team for a resource-packed day designed to fast-track your lesson planning and preparation for the new Edexcel A Level Business specification. We'll look at the key changes in teaching content, explore the new challenges of teaching this linear specification and dive into some brand new teaching resources designed specifically for the new Edexcel A Level Business course from September 2015.
Worked A Grade answers to recent AQA GCSE Business Studies Unit 1 exam papers together with detailed examiner commentary
A complete collection of editable worksheets that that enable students to practice all elements of the quantitative and data analysis skills required by the Year 1 (AS) teaching content.