Organisations and the financial system
Organisations and the financial system

Start this free course now. Just create an account and sign in. Enrol and complete the course for a free statement of participation or digital badge if available.

Free course

Organisations and the financial system

Retained earnings

Retained earnings are the portion of past earnings retained within the business itself. They are an important source of internal finance for businesses looking to finance long-term projects.

For a business to be able to rely on these earnings to fund its activities, it has to have first made profits. As a result, this method could be difficult to use for newly established businesses due to the usually limited profitability in the first stages of production caused by significant initial costs. And even for profitable companies, satisfying this first condition alone is not entirely sufficient as they will need to take into consideration how much of their profits to distribute in the form of dividends to the shareholders before accounting for profits that are retained (if any). The following formula summarises the calculation of retained earnings in a given year:

Retained earningst = retained earningst − 1 + income (loss)tdividends distributedt

Where t represents the current time.

From the above formula it is evident that retained earnings carry opportunity cost for the company, which has to carefully consider the consequences of deciding not to distribute them to investors. In fact, the higher the dividends distributed to shareholders, the lower the amount of retained earnings and vice versa.

You will now look at the main external sources of financing.


Take your learning further

Making the decision to study can be a big step, which is why you'll want a trusted University. The Open University has 50 years’ experience delivering flexible learning and 170,000 students are studying with us right now. Take a look at all Open University courses.

If you are new to University-level study, we offer two introductory routes to our qualifications. You could either choose to start with an Access module, or a module which allows you to count your previous learning towards an Open University qualification. Read our guide on Where to take your learning next for more information.

Not ready for formal University study? Then browse over 1000 free courses on OpenLearn and sign up to our newsletter to hear about new free courses as they are released.

Every year, thousands of students decide to study with The Open University. With over 120 qualifications, we’ve got the right course for you.

Request an Open University prospectus371