Over the course of time, it can be seen that there has been remarkable innovation when it comes to options that the companies have pertaining to raising funds for their expansion, or any other usage.
In this regard, it is imperative that there are numerous options that companies now have relating to the options they can exercise when it comes to raising funds.
Retained Earnings tend to be one of the primitive choices of concern for the company, essentially because of the relative ease with which this option can be utilized to fulfill the objectives of the company.
What are Retained Earnings?
Retained Earnings can simply be defined as the amount that the company has in reserve, after all the expenses have been paid out.
Factually, this is a reserve that the company holds, as excess of revenues over expenses, accumulated over a given time frame.
Therefore, these reserves are meant to be used by the company in order to get a proper insight regarding the company, and how this issue can be used for the advantage for the company so that they are able to extrapolate desired results when it comes to fulfilling their objectives.
Are Retained Earnings a Good Source of Funding for the company?
Retained Earnings are the personal funds held by the company, and therefore, the company legally owns this particular asset and can use them as per their discretion.
Retained earnings are concerned to be a top-notch choice for funding within the company because of a number of reasons.
Firstly, it can be seen that since these are the resources that are held in possession by the company, this amount does not have to be paid back.
This can be considered as a huge plus from the perspective of the company since there is no principle which has to be returned after a certain point in time.
These resources can, therefore, be utilized for the greater advantage of the company.
In the same manner, retained earnings do not tend to incur a financial charge for the company.
Unlike other options that the companies have when it comes to funding, it can be seen that retained earnings are concerned, this is something that does not perturb the financials of the company when it comes to interest charges or other relevant charges that the company might otherwise have to bear.
As far as retained earnings are concerned, they are utilized by the company’s personal resources, and hence, they can always be replenished with profits in the coming years.
It does not alter the company’s leverage, or ownership structure in any manner.
Therefore, this can be considered very attractive from the perspective of the owners, or existing shareholders, because their ownership in the company is not going to be diluted.
However, the caveat when it comes to utilization of retained earnings for the company is concerned, it can be seen that it is quite imperative that the company might not always have a significant amount of retained earnings to utilize for purposes of expansion, or other resources.
Hence, this option might not always exist for most companies, for that matter.
In the same manner, usage of retained earnings also involve an opportunity cost. This includes these resources would then not be available to distributed amongst the existing shareholders.
This is primarily because of the reason that retained earnings that would be utilized for the company’s expansion, and therefore, this amount is not going to be available for shareholders as their dividends.
This might result in shareholders being relatively on the back foot in this regard because their own dividends might be at stake.
Therefore, it can be seen that retained earnings can be considered as an extremely crucial factor in gathering funds for the company, because of the immense usefulness it has in terms of solving finance-related issues within the company.
In this regard, it is also important to consider the fact that these retained earnings can subsequently lead to company expanding, without changing their existing capital structure, or their risk hedging strategies.
Regardless of the fact that this might not be sufficient to deal with expansionary issues within the company, yet it can be seen this amount might not always be sufficient.
However, this issue can also be resolved by using a mixture of both, retained earnings, and some other form of external financing (like loans) in order to finance the desired program for the company.
This can help the organization to get benefits of both, internal as well as external financing.