DEFINITION of Accumulated Income
Accumulated income includes the portion of net income that is retained by a corporation instead of being distributed as dividends. Any accumulated income is typically used by the corporation to reinvest in its principal business or to pay down its debt. Accumulated income appears under shareholder's equity on the corporation's balance sheet.
Accumulated income is called "retained earnings" far more in practice.
BREAKING DOWN Accumulated Income
Accumulated income refers to the percentage of net income that is accumulated and used for reinvestment purposes or to pay down debt rather than being paid out in the form of dividends. Accumulated income is often invested in areas within the corporation that will create growth opportunities, such as research and development, new technology or machinery and other forms of capital expenditures.
A business needs accumulated income to help fund its operations. This is especially important for a growing business, which typically requires a substantial amount of working capital to pay for its ongoing investments in receivables and inventory, as well as fixed asset purchases.
The amount of accumulated income tends to be lowest in slow-growth businesses, where the management team has no internal use for the money and so elects to send it to investors in the form of dividends.
From a theoretical perspective, accumulated income or retained earnings plays a central role in capital structure and capital budgeting decisions. When the dust settles at the end of the year, a business can generally do one of two things with excess cash. It can either plow it back into the business to improve or grow organically. It can also return capital to its rightful owners, be they equity shareholders or creditors.
Businesses with growth prospects greater than their cost of capital should, in theory, put the money back into the business to generate capital investment growth. If shareholders are satisfied with growth given a level of risk, they do not raise their cost of funds. However, when a business is facing deteriorating financial prospects, investors frown upon these businesses retaining too much cash because it often gets wasted on risky ventures and frivolous pet projects.