Revenue is the total income earned from the sale of goods and services, while retained earnings is the amount of net income retained by a company. Both revenue and retained earnings are important in evaluating a company's financial health, but highlight different aspects of the financial picture.
Revenue sits at the top of the income statement and is often referred to as the top-line number when describing a company's financial performance. Since revenue is the total income earned by a company, it is the income generated before operating expenses, and overhead costs are deducted. In some industries, revenue is called gross sales since the gross figure is before any deductions. However, net sales can be used in place of revenue since net sales refers to revenue minus any exchanges or returns by customers. For example, net sales is used by the retail industry.
Retained earnings is the portion of a company's profit that is held or retained and saved for future use. Retained earnings could be used for funding an expansion or paying dividends to shareholders at a later date. Retained earnings is related to net income since it's the net income amount saved by a company over time.
Net income is the profit earned for a period and is calculated by subtracting all of the costs of doing business. Those costs can include operating expenses, such as rent, utilities, and payroll, overhead costs or sales, general, and administrative costs, interest on debt, and depreciation.
Net income is often called the bottom line since it sits at the bottom of the income statement. When the net income is not paid out to shareholders or reinvested back into the company, it becomes retained earnings. It's important to note that retained earnings is an accumulated balance that could be the result of many quarters or years, similar to a savings account.
Calculating Retained Earnings
Retained earnings is listed on a company's balance sheet under the shareholders' equity section. However, it can also be calculated by taking the beginning balance of retained earnings, adding the net income (or loss) for the period followed by subtracting any dividends paid to shareholders.
For example, a company has the following numbers for the current period:
- A beginning retained earnings balance of $5,000 when the reporting period began,
- Net income of $4,000 for the period,
- Dividends paid of $2,000,
Retained earnings at the end of the period is:
Retained Earnings Beginning Balance + Net Income (or loss) – Dividends
Retained Earnings = $5,000 + $4,000 - $2,000 = $7,000
The difference between revenue and retained earnings is that revenue is the total amount of income made from sales while retained earnings reflects the portion of profit a company keeps for future use.
Revenue and retained earnings are correlated to each other since a portion of revenue, in the form of profit, may ultimately become retained earnings. The amount of profit being held in retained earnings is particularly important to shareholders since it provides insight into a company's ability to fund dividends or share buybacks in the future.
The ratio between revenue and retained earnings can also illustrate how effectively a company invests in the long-term health of the company. For example, a company may use retained earnings to fund purchases of fixed assets or property, plant, and equipment.
The amount of profit retained can show how well a company manages their earnings after expenses, how efficient it is in its business operations, whether it's holding a large amount of cash, and whether a company is being too aggressive or too conservative with its investments or capital expansion.
Since retained earnings is a cumulative amount of profit, it can be much larger with older companies as compared to newer companies. One method used to compare the retained earnings of different companies is to divide retained earnings by the total number of the company's reported years in operation. The result provides an average annual retained-earnings amount.
For more on this topic, please read Which transactions affect retained earnings?