STATEMENT OF RETAINED EARINGS AND ITS COMPONENTS

RETAINED EARNINGS is the percentage of net earnings not paid out as

dividends, but retained by the company to be reinvested in its core business
or to pay debt. It is recorded under shareholders' equity on the balance
sheet.
The Statement of Retained Earnings
The statement of retained earnings reconciles changes in the retained
earnings accounting during a reporting period. The statement begins with
the beginning balance in the retained earnings account, and then adds or
subtracts such items as profits and dividend payments to arrive at the
ending retained earnings balance. The general calculation structure of the
statement is:
Beginning retained earnings + Net income - Dividends = Ending retained
earnings
The statement of retained earnings is most commonly presented as a
separate statement, but can also be appended to the bottom of another
financial statement. Retained earnings are still owned by the shareholder
and are still a part of a shareholder's total equity in the company.
Uses of Retained Earnings
Retained earnings may be used to reinvest in the company in several key
ways. Sometimes, companies use retained earnings to buy new equipment
or repair existing equipment. It may also be used to increase a company's
income by investing in advertising. Alternatively, retained earnings may be
used to hire, train and pay new workers, or to purchase new real estate for
expanding the business.
Investor Oversight
Once retained earnings have been reinvested in a company, shareholders
expect them to earn a certain amount of money. If retained earnings are
used in a manner which creates greater income for the company, most
shareholders will agree that the company has invested retained earnings
wisely. If retained earnings are not spent wisely, shareholders will be less
likely to allow a company to use retained earnings in the future and will

instead ask that the company pay dividends. A shareholder usually expects
retained earnings to be invested to bring in at least as much of a return as if
the shareholder had invested the money in other stocks or companies.
Factors that can affect a company's retained earnings balance:

A change in net revenue

A change in the amount of money paid as dividends to investors

A change in the cost of goods sold

A change in administrative costs

A change of taxes

A change in the company's business strategy

HOW TO CALCULATE RETAINED EARNINGS

Retained earnings are a permanent account that appears on a business's
balance sheet under the Stockholders Equity heading. The account balance
represents the company's cumulative earnings since formation that have not
been distributed to shareholders in the form of dividends. If the retained
earnings account has a negative balance, it is called "accumulated deficit."
Net income - dividends paid out = retained earnings
Next, to find the business's cumulative retained earnings, add the retained
earnings value you just calculated to its most recent retained earnings
balance.
For example, let's say that at the end of 2011 your business has $512 million
in cumulative retained earnings. In 2012, your business made $21.5 million
in net income and paid $5.5 million in dividends. Your business's current
balance for retained earnings is:
21.5 - 5.5 = 16
512 + 16 = 528. Your business has made $528 million in
retained earnings.
Alternative Method

Calculate Gross Margin

Gross margin is a figure presented on a multiple-step income statement and
is determined by subtracting the costs of a company's goods sold from the
money generated from the sales.
For example, let's say a company makes $150,000 in sales for one quarter,
but had to spend $90,000 to buy the goods necessary to make that
$150,000. Gross margin for this quarter would be $150,000 - $90,000
= $60,000.
Calculate operating income
Operating income represents a company's income after all sales
expenses and operating (ongoing) expenses, like wages, have been paid. To
calculate it, subtract a business's operating expenses (besides the cost of
goods sold) from the gross margin.
Let's say that, in the same quarter that our business made $60,000 in gross
margin, it paid $15,000 in administrative expenses and wages. The
business's operating income would be $60,000 - $15,000 = $45,000.
Calculate pre-tax net income
To do this, subtract expenses due to interest, depreciation, and amortization
from the company's operating income. Depreciation and amortization - the
reduction in value of assets (tangible and intangible) over their life - are
recorded as expenses on income statements. If a company buys a $10,000
piece of equipment with a 10-year life span, it would result in a $1,000
depreciation expense each year, assuming its value depreciates at an even
rate.
Let's say that our company had $1,200 in interest expenses and $4,000 in
depreciation expenses. Our company's pre-tax net income would be $45,000
- $1,200 - $4,000 = $39,800.
Calculate after-tax net income
The final expense we must account for is taxes. To do this, first apply the
company's tax rate to their pre-tax net income (by multiplying them
together). Then, to get after-tax net income, subtract this amount from the
pre-tax figure.

In the example, let's assume we're taxed at a flat 34% rate. Our tax
expenses would be 34% (0.34) $39,800 = $13,532.
Next, subtract this from the pre-tax amount as follows: $39,800 - $13,532 =
$26,268.
Finally, subtract dividends paid
Now that weve found our companys net income after all expenses have
been accounted for, we have a value we can use to find retained earnings for
the current recording period. To find this value, subtract dividends paid from
the after-tax net income.
In this example, assume the dividends paid were $10,000 this quarter. The
current periods retained earnings would be $26,268 - $10,000 or $16,268.

STATEMENT OF CASH FLOW AND ITS COMPONENTS

Statement of Cash Flows, also known as Cash Flow Statement, presents the
movement in cash flows over the period as classified under operating,
investing and financing activities.
The document provides aggregate data regarding all cash inflows a company
receives from both its ongoing operations and external investment sources,
as well as all cash outflows that pay for business activities and investments
during a given quarter.
As income statement and balance sheet are prepared under the accruals
basis of accounting, it is necessary to adjust the amounts extracted from
these financial statements (e.g. in respect of non-cash expenses) in order to
present only the movement in cash inflows and outflows during a period.

All cash flows are classified under operating, investing and financing
activities as discussed below.
Cash Flow from Operating Activities (CFO)
CFO is cash flow that arises from normal operations such as revenues and
cash operating expenses net of taxes. This includes:
Cash inflow (+)

Revenue from sale of goods and services

Interest (from debt instruments of other entities)
Dividends (from equities of other entities)

Cash outflow (-)

Payments
Payments
Payments
Payments
Payments

to suppliers
to employees
to government
to lenders
for other expenses

Cash Flow from Investing Activities (CFI)

CFI is cash flow that arises from investment activities such as the acquisition
or disposition of current and fixed assets. This includes:
Cash inflow (+)

Sale of property, plant and equipment

Sale of debt or equity securities (other entities)
Collection of principal on loans to other entities

Cash outflow (-)

Purchase of property, plant and equipment

Purchase of debt or equity securities (other entities)
Lending to other entities

Cash flow from financing activities (CFF)

CFF is cash flow that arises from raising (or decreasing) cash through the
issuance (or retraction) of additional shares, short-term or long-term debt for
the company's operations. This includes:
Cash inflow (+)

Sale of equity securities

Issuance of debt securities

Cash outflow (-)

Dividends to shareholders
Redemption of long-term debt
Redemption of capital stock

Purpose & Importance

Statement of cash flows provides important insights about the liquidity and
solvency of a company which are vital for survival and growth of any
organization. It also enables analysts to use the information about historic
cash flows to form projections of future cash flows of an entity (e.g. in NPV
analysis) on which to base their economic decisions. By summarizing key
changes in financial position during a period, cash flow statement serves to
highlight priorities of management. For example, increase in capital
expenditure and development costs may indicate a higher increase in future
revenue streams whereas a trend of excessive investment in short term
investments may suggest lack of viable long term investment opportunities.
Direct and Indirect Method
Only the operations section deals with the question of direct versus indirect
cash flows. By comparing the operations section with the income statement,
one can identify the differences in timing between income and cash
collections. Comparison also reveals timing differences between expenses
and cash payments. Large differences might indicate that the company is
very aggressive in recognizing income, or that the company spends a lot of
cash to buy or maintain assets, a fact not apparent from the income
statement.

Indirect Method
In the indirect method, adjust net income to convert it from an accrual to a
cash basis. The indirect method is preferred by most firms because it shows
reconciliation from reported net income to cash provided by operations.
Calculating Cash flow from Operations
Here are the steps for calculating the cash flow from operations using the
indirect method:
1. Start with net income.
2. Add back non-cash expenses. (Such as depreciation and amortization)
3. Adjust for gains and losses on sales on assets.
a. Add back losses
b. Subtract out gains
4. Account for changes in all non-cash current assets.
5. Account for changes in all current assets and liabilities except notes
payable and dividends payable.

Cash Flow from Investment Activities

Cash Flow from investing activities includes purchasing and selling long-term
assets and marketable securities (other than cash equivalents), as well as
making and collecting on loans.

Cash Flow from Financing Activities

Cash Flow from financing activities includes issuing and buying back capital
stock, as well as borrowing and repaying loans on a short- or long-term basis
(issuing bonds and notes). Dividends paid are also included in this category,
but the repayment of accounts payable or accrued liabilities is not.

Direct Method
The direct method is the preferred method under FASB 95 and presents cash
flows from activities through a summary of cash outflows and inflows.

However, this is not the method preferred by most firms as it requires more
information to prepare.
Cash Flow from Operations
Under the direct method, (net) cash flows from operating activities are
determined by taking cash receipts from sales, adding interest and
dividends, and deducting cash payments for purchases, operating expenses,
interest and income taxes.

Cash collections are the principle components of CFO. These are the
actual cash received during the accounting period from customers.
They are defined as:
Cash Collections Receipts from Sales = Sales + Decrease (or increase) in Accounts Receivable
Cash payment for purchases make up the most important cash outflow
component in CFO. It is the actual cash dispersed for purchases from
suppliers during the accounting period. It is defined as:
Cash payments for purchases = cost of goods sold + increase (or
- decrease) in inventory + decrease (or - increase) in accounts payable
Cash payment for operating expenses is the cash outflow related to
selling general and administrative (SG&A), research and development
(R&A) and other liabilities such as wage payable and accounts payable.
It is defined as:
Cash payments for operating expenses = operating expenses +
increase (or - decrease) in prepaid expenses + decrease (or - increase)
in accrued liabilities
Cash interest is the interest paid to debt holders in cash. It is defined
as:
Cash interest = interest expense - increase (or + decrease)
interest payable + amortization of bond premium (or - discount)
Cash payment for income taxes is the actual cash paid in the form of
taxes. It is defined as:
Cash payments for income taxes = income taxes + decrease (or
- increase) in income taxes payable

The calculations for cash flow from financing and investing activities are the
same as the indirect method.

REFERENCES

http://www.investopedia.com/terms/r/retainedearnings.asp
http://www.accountingcoach.com/blog/what-is-retained-earnings

http://smallbusiness.chron.com/key-components-retained-earnings26010.html
http://www.wikihow.com/Calculate-Retained-Earnings
http://www.accountingcoach.com/cash-flow-statement/explanation/4
http://www.accountingtools.com/statement-of-cash-flows
http://accounting-simplified.com/financial/statements/cash-flowstatement.html#template
http://www.investopedia.com/terms/c/cashflowstatement.asp
http://www.investopedia.com/articles/04/033104.asp
http://www.accountingcoach.com/blog/direct-and-indirect-methodcash-flows