What Are The Advantages and Disadvantages of Retained Profit?

Retained profit is a portion of money kept within business accounts from net income. Despite allowing companies more opportunities to support the growth of their businesses, many believe that retained profit comes with some disadvantages. To explore the key advantages and downfalls of retained profit, continue reading.

What is Retained Profit?

Retained profit, commonly referred to as retained earnings, is the amount of money left in a business once all the company’s shareholders have received their dividends.

The process of calculating retained profit is done using the total amount of net income. It’s considered a vital financial metric, helping you better understand the overall financial stability of your business.

Essentially, any amount of earnings that are kept on the books after important payments, such as dividends or tax are paid out, will equal your company’s retained profit.

Retained Profit Formula Example

Understanding and calculating retained profit may be new to you – but we’re here to break it down. The formula to calculate retained earnings is simply:

Beginning retained profits + net income – dividends = all retained profits.

Don’t worry if you’re still feeling confused. All this calculation includes is your beginning retained profits from the previous period, plus the net income from the current period, minus any dividends paid out to shareholders.

For example:

• Beginning retained profits = £12,000
• Net income for that period = £6,000
• Dividends paid to shareholders = £2,000

Your company’s retained profits = £12,000 + £6,000 – £2,000 (equalling to £16,000).

Using Retained Profit

Not every company will make a retained profit. For many, using retained profit seems beneficial – but this depends on your business circumstances. If you do make a retained profit, you’ll have a few decisions to consider:

• Reinvest back into your business
• Use towards your personal income
• Pay off existing debts
• Take out as shareholder payments

Ultimately, the decision as to whether you use retained profit or not comes down to the financial position of your business. Retained earnings have helped many businesses across the UK support the future growth of their company.

Advantages vs Disadvantages of Retained Profit

Like most things, there are both pros and cons to having retained profits. All businesses should weigh up both the advantages and disadvantages of retained profit.

Advantages

• Popular for long-term financing
• Provides a safety net
• Enhances your company’s financial position
• Allows for more funds to grow your business
• Raises your company balance sheet

Disadvantages

• May cause your business to miss out on higher-return investments
• Potentially result in shareholder dissatisfaction
• Could cause tax issues

As you can tell, the advantages of retained profit certainly outweigh the potential negatives. However, balancing all of these factors is vital while planning for the future success of your business.

How Much Profit Should Your Business Retain?

There is no set answer to how much profit businesses should retain. The amount you retain depends on several key factors, including:

1. The type of company
2. The size of your company
3. The stage your company is in
4. The industry your company is in
5. The growth strategy set in place

Most companies will decipher the amount of profit they retain based on their long-term financial strategy. However, it’s important to consider the urgent needs of your business while deciding how much profit to retain.

If there are areas that require improvement to maintain steady growth and a profitable future, you should think about using profit to address current issues.

Financial Support at DH Business Support

Staying on track with your company’s finances can be difficult – but this is where we step in. At DH Business Support, we understand the challenges that many businesses face when it comes to increasing retained profits.

We consist of a friendly and professional team, with years worth of industry knowledge. Our team of trusted chartered accountants are here to provide real-time financial data to ensure you make the most informed decisions to positively impact your profits.

Through our management reporting services, we can ensure that you hit your targets while having full control and visibility over your business’s finances. Our services will be explained to you clearly, ensuring you’re kept in the loop at all times.

To find out more, please don’t hesitate to contact us today. We look forward to hearing from you.