The complicated web of corporate finance includes all manner of overlapping terms and concepts, the relationships between which often provoke confusion. Among these related terms are retained earning and stockholders equity. Both of these concepts arise from the same field – capital structure. Despite their similar origin, retained earnings and stockholder equity differ in a number of important ways.
Retained earnings arise from company profits. When a company issuing stock earns a profit during the fiscal year, it holds two options. It can distribute profits to shareholders as dividends in equal proportion to the number of shares each investor owns or it can reinvest them in the company. Profits reinvested in a company constitute retained earnings. Companies often attempt to balance the need to bolster a company through retained earnings with the owners’ desire to earn dividends.
Stockholder equity constitutes all the assets of a company to which the shareholders own a claim. Calculating stockholder equity entails subtracting the value of all liabilities, or outstanding debts, from the value of all assets of a company. Assets constitute anything of value a company owns, from tangible property such as buildings and equipment to cash, bank accounts, securities and commodities and intangible assets such as patents and franchise rights. Due to the nature of corporate financing, investors do not assume responsibility for a company’s liabilities.
Retained earnings and stockholder equity are fundamentally different. The former constitutes a stream of revenue derived from company profits, the latter a form of valuation. Furthermore, stockholder equity constitutes a set thing. Every company issuing shares maintains stockholder equity, whether it wants to or not. However, the board of a corporation must make an active decision with regard to keeping retained earnings versus paying dividends. Furthermore, retained earnings arise only in the event of profits, while stockholder equity exists regardless.
A measure of overlap occurs between stockholder equity and retained earnings in that the latter constitutes one of the many compositional elements of the former. Though stockholders don’t get direct access to retained earnings as they do with dividends, if a company goes bankrupt, investors get this money in the liquidation of company assets. Furthermore, both of these concepts arise directly from capital structure, or the financing network of corporations, which includes stock, liabilities such as bonds and loans and more.