Retained earnings represent the income that the firm has earned over the years that has not been distributed to the stockholders in dividends. Retained earnings, like all items on the equity side of the balance sheet, represent a claim on a portion of the assets and are assets themselves. Retained earnings does not imply that somewhere the firm has that amount of cash readily available that could be be distributed as dividends. More generally, the profits that were not distributed to the owners was reinvested into the firm in order to generate larger profits in the future. The income statement or a company compares its revenues to its expenses.
Net income is the difference between revenues and expenses.
The simplest form of an income statement appears in Figure Two. The income statement is used as a vehicle for the presentation of changes in retained earnings from year to year. Since increasing the wealth of the stockholders is a key goal of a company, it is important to convey to the stockholders changes in the amount of the company's income that is being retained for future expansion and other investments to further the growth of the company. A combined statement of income and retained earnings might appear as in Figure Three. Dividends declared during the year are then subtracted as a distribution to the stockholders of a portion of the accumulated company earnings.