An essential amount that corporations need to calculate at the end of every accounting period, is their accumulated profit.
Accumulated profit, also known as retained earnings, is the cash that remains after companies distribute dividends to their shareholders. The value is part of a business’s balance sheet - more specifically, it’s listed under the shareholder’s equity division.
In this guide, we’ll be explaining its importance, how to calculate it, and everything else you need to know about managing accumulated profit for your business.
Read along to learn about:
- What Is Accumulated Profit?
- Why Does Accumulated Profit Matter?
- How To Calculate Accumulated Profit
- Automate Accumulated Profit with Accounting Software
- Accumulated Profit FAQ
What Is Accumulated Profit?
Accumulated profit refers to the net profit remaining after dividend payments have been made to stockholders. You might also encounter the term as accumulated earnings, retained earnings, undistributed income, or income reserve - these all represent the same thing.
When there’s an earning surplus, meaning there’s profit left after dividends are paid out, management can either choose to save it or reinvest it into the business. The reinvestment can cover a broad range of possibilities, such as:
- Expanding business operations by hiring more employees, working in new territories, targeting new consumer markets, and so on.
- Putting money into marketing efforts, new products, or increasing the production capacity of already existing products.
- Spending on market research and development opportunities.
- Merging, acquiring, or forming a partnership that benefits the business.
- Payment of any existing loans and liabilities.
The decision is made among the shareholders or is left to the management of the business. However, sometimes, if the choice of the management isn’t satisfactory, it may be challenged by shareholders through a majority vote, as they are the actual owners of the company.
Why Does Accumulated Profit Matter?
Compared to revenue or net income, accumulated profits present a much fuller view of your company's financial health. They show how your company has earned, reserved, and invested cash over a long period of time, whereas revenue and income frequently fluctuate and don’t provide as much insight.
Hence, accumulated profit is necessary for a business to expand and grow, continuously invest in new products and services, and stay on top of the competition. Investors and stakeholders also take a specific interest in the business’ accumulated profit when reviewing your accounting reports, to assess your financial credibility.
Want to learn how to summarize your key financial insights and generate financial statements for your small business accounting? Then, head over to our guide on financial reporting for more.
How To Calculate Accumulated Profit
Dividends can be distributed in the form of cash or stock, so both types of distribution can reduce retained earnings. That’s why the formula for calculating accumulated profits is:
Accumulated Profit = Accumulated Profit Beginning of the Year - Cash Dividends - Stock Dividends
Let’s illustrate with an example.
Say Company ABC begins a new accounting period, which corresponds with the beginning of the year, with $200,000 in retained earnings. During this year, the company suffered a net loss of $50,000. At the end of the year, the company pays out $5,000 in dividends to its shareholders.
The formula for the company’s accumulated earnings for the end of the year would be:
$200,000 - $50,000 - $5,000 = $145,000
This amount will be carried over to the new accounting period and can be used to reinvest into the business or to pay future dividends.
Automate Accumulated Profit with Accounting Software
By using cloud-based accounting software, you can keep track of all of your profit, expenses, dividends, and other financial operations through a single intuitive dashboard.
Deskera offers one of the best all-inclusive accounting software for small businesses today.
From the Sell dashboard, you can manage your sales and orders from start to finish, create estimates and convert to invoice upon confirmation, receive and record online payments automatically, fulfill orders, and keep track of your cost of goods sold.
Then, you can use the Buy platform to record purchase orders, bills, and overview your payables and expenses, in a matter of seconds.
The software then uses this data to cover all of your reports, from the income statement, balance sheet, and statement of cash flow, all the way to the initial general ledger and trial balance reports.
The best part?
These features can be accessed anytime, anywhere, through Deskera’s online dashboard on your desktop screen, and by downloading the Deskera mobile app on your mobile phone or tablet.
Give financial accounting with Deskera a try right now, by signing up for our free trial. No credit card details required.
Accumulated Profit FAQ
#1: When Should Accumulated Profits Be Updated?
It’s best to update your accumulated profit at the end of each accounting period to see how income has fluctuated from year to year. The accounting period can correspond to one month, three months, half a year, or a year’s time frame, depending on how often you want to gain insights into your accumulated earnings.
#2: What’s the Difference Between Accumulated Profit and Revenue?
Both revenue and retained earnings are important measures in assessing a business’s financial health, however, they focus on different aspects of the financial picture.
Revenue is included at the very top of the income statement, and it’s the total income earned by a business, before any business expenses and overhead costs have been deducted.
Whereas accumulated earnings are part of the balance sheet, and represent a portion of a business’s profits, held for future use - be that the funding or expansion of business operations, investments in a new product, and so forth.
#3: Is Accumulated Profit in Equity?
Yes, accumulated profit is part of a shareholder’s equity. It appears under the shareholder’s equity section on the balance sheet.
#4: How Do You Avoid Accumulated Profit Tax?
Right now, corporations have an exemption amount of $250,000. Any accumulated profits above this number are taxed at 20%, unless the capital accumulation is done for “reasonable business needs”, such as business expansion, debt payments, purchasing another business, and so forth.
The safest way you can stay clear of accumulated taxable income, or accumulated profit tax, is to maintain your company’s account balance below these levels of standard credits.
Make sure you’re paying out all of your dividends regularly, assess and report all your maintenance and safety costs, justify your accumulated profits, and consult an accountant in case of any issues.
And that’s a wrap!
For a quick recap, let’s go through some of the main points we covered:
- Accumulated profit is the remaining profit corporations own after deducting dividend expenses. It can either be saved or reinvested within the business.
- Accumulated profit is calculated by subtracting cash and stock dividends from the accumulated profits at the beginning of the accounting period.
- In comparison to other revenue measurements, the value of accumulated earnings is the fullest view of a company’s financial health.