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The Retained Earnings Statement -- Explained

By Rich Smith - Sep 4, 2015 at 5:02PM

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Here's a simple explanation that anyone can understand.

Company annual reports contain a lot of charts. Of these, retained earnings statements are perhaps the easiest to understand.

Today we're going to spend a (very) few words talking about the retained earnings statement, perhaps the financial document least often discussed when financial media report on earnings news. It's a pretty simple document, however, easy to understand, and gives you an at-a-glance look at what a company has been doing lately with the profits it earns.

Different companies depict changes in their retained earnings (profits kept in-house for reinvestment in the business, rather than returned to shareholders) in different ways.  The following example, drawn from Microsoft's (MSFT -0.40%) July 10-K filing in with the SEC, is pretty typical though:

Retained Earnings (Deficit)

2015

2014

2013

Balance, beginning of period

17,710

9,895

(856)

Net income

12,193

22,074

21,863

Common stock cash dividends

(10,063)

(9,271)

(7,694)

Common stock repurchased

(10,744)

(4,988)

(3,418)

Balance, end of period

9,096

17,710

9,895

All numbers (other than the years, which represent financial years ending June 30), in millions of dollars.

So what is Microsoft trying to tell us here? Focusing on the first few lines, we see that Microsoft has been using its strong GAAP profits to steadily increase retained earnings over the past few years. Its profits have been so strong that Microsoft has been able to do this despite steadily increasing dividend payouts and stock repurchases (both of which subtract from retained earnings).

Sea change (see the change?)
In the most recent year's financial results, however, we saw a steep decline in profits. Yet Microsoft didn't just maintain its dividends and stock repurchases -- it accelerated them. Dividend payouts grew 8.5%, and stock repurchases more than doubled. As a result, although Microsoft went into fiscal 2015 with $17.71 billion in retained earnings on its balance sheet , it ended the year with quite a bit less.

Over the course of the fiscal year, the retained earnings statement shows that the company added $12.193 billion in profits to its initial retained earnings. Microsoft paid out 82.5% of those profits in the form of dividends, then dug into its savings to come up with a further $10.744 billion -- which it spent buying back its own stock. As a result, Microsoft actually returned more cash (in the form of dividends and buybacks) to shareholders in fiscal 2015 than it earned in profits.

And of course, it was able to do this because it had retained earnings in previous years, which it could now draw upon to pay for the dividends and buybacks.

What to expect from next year's retained earnings statement
And so you can see, Microsoft's retained earnings statement quickly shows us how it ended the year with less retained earnings than it began with.

Largely, this happened because the company took a massive $7.5 billion non-cash charge  to earnings for its acquisition of Nokia Devices and Services, which bit deeply into net income in fiscal 2015. With that charge not repeating in fiscal 2016, net income should quickly rebound. In all likelihood, this time next year, we'll all be talking about how Microsoft entered the year with $9.1 billion in retained earnings, spent boatloads of cash on dividends and buybacks -- yet still ended up spending less than it earned.

And the whole story will be laid out in one simple retained earnings statement.

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