Sometimes referred to as earned surplus, accumulated earnings are revenue or earnings that are received by a company, but are not paid out as dividends to the investors of the company. There are several reasons why accumulated earnings are important to the financial stability of many corporations. Here are some examples of how accumulated earnings can be an asset in business operations.
The key point to remember about accumulated earnings is that the earnings represent revenue generated by the company. More importantly, accumulated earnings illustrate that the company is making a profit that is capable of generating dividends for the investors. The fact that the company is successful enough to pay dividend benefits to investors is one way of demonstrating a healthy corporation.
However, instead of paying dividends to investors, the retained earnings are reinvested in the company in one of two ways. First, the unappropriated profit may be used to pay down any outstanding debt currently owed by the company, such as loans or other obligations. Because accumulated earnings represent funds that are not necessary to meet the usual operating expenses of the company, choosing to use the earnings to pay off outstanding debt can often make a good situation even better. Less outstanding debt translates into an increased profit margin in the years to come.
A second common use for accumulated earnings is to take the money to purchase upgraded equipment or otherwise fund a project that will enhance the ability of the company to be profitable. For example, the earnings may be used to purchase new equipment for the operation, or to fund a marketing campaign for a new product or service. Using the accumulated earnings for investing in the future of the company often leads to higher profits for the corporation over time, which will in turn generate more accumulated earnings in the years to come.
While paying dividends is often an important portion of running a business, many investors are more than willing to forego receiving a small dividend today in anticipation of receiving a larger return on the investment in the future. After all, ensuring the financial and operational health of the corporation will mean the initial investment will pay off, and not be lost to corporate failure. By allowing the accumulated earnings to be used for reduction or elimination of current debt or as an infusion of cash to fund a new marketing campaign, the chances for realizing a larger return for the investment are much greater. As any investor understands, increased returns are always desirable.
