Retained earnings

What it means

Retained earnings are the part of past years’ profit or loss that the general meeting did not distribute and left inside the company. They are reported within equity, not on a bank account.

They are not spare cash. The money that profit once brought in has long since turned into stock, receivables or a machine, so a company can carry large retained earnings and still be short for payroll.

Retained earnings are the free part of equity that the general meeting can still decide on several years later. That sets them apart from the reserve fund and other funds created from profit, which already have a set purpose and cannot be paid out, and from the current year’s result, which moves into retained earnings only once the statements are approved.

How it works in practice

The general meeting decides what happens to the profit, and only after approving the statements. Until that resolution exists, the amount sits in the retained earnings account and cannot be paid out.

Distribution follows an order: the accumulated loss and the mandatory transfer to the reserve fund come first, and only the remainder goes to the owners. A dividend paid to an individual is subject to withholding tax.

Retained earnings need not be paid out; they can also be used to increase the registered capital from the company’s own resources. The owners put in no new money: a general meeting resolution and an entry in the Commercial Register are enough, and for that step we prepare a note showing which approved statements the amount comes from.

What to watch out for

Owners draw money during the year and call it a dividend, although the statements are not approved and no distribution resolution exists. The tax administrator reclassifies the payment as a shareholder loan or as other income and assesses tax on it with a penalty.

Profit may not be distributed if doing so would drive the company into insolvency, however large the retained earnings in the balance sheet. A shareholder must return a dividend paid in breach of the law, and a director who allowed the payment without checking the company’s ability to pay is liable to creditors for the damage.