What are retained earnings?

Retained earnings represent the accumulated portion of a corporation's net income that is retained within the company rather than distributed to shareholders in the form of dividends. This means that retained earnings are calculated as the excess of a corporation’s income over the dividends declared. Therefore, when a company earns profits, it has the option to either reinvest those earnings back into the business or distribute them as dividends to shareholders. If the company opts to retain more of its income by paying out fewer dividends, the retained earnings balance increases, which can be used for future investments, debt repayment, or other business expenses.

This concept is fundamental in understanding how a company utilizes its profits to fuel growth and maintain liquidity. It reflects financial health and the ability to finance operations without needing to seek outside capital. The other choices do not accurately encapsulate the definition of retained earnings: they either refer to dividends declared, total income, or cash flow, which are distinct financial concepts that do not specifically define retained earnings.