I'm trying to describe retained earnings. How is this for a simple explanation?
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One of the confusing entries on the QuickBooks balance sheet is "retained earnings". There's no account associated with this anywhere to examine. When you click on it, it just shows you that one line. Just what is a Retained Earnings?
In essence, Retained Earnings is "what your company had as a value at the start of the year". Let me warn first that this is a very simplified explanation
Everything in accounting is supposed to balance out. The stuff on the left half of the chart is supposed to equal to the stuff on the right half of the chart. So when you do a balance sheet, you have on one side all your assets. Your bank accounts. Your physical possessions. Let's say that adds up to $100,000.
Now on the other half of the equation you have the things that you are liable for. Loans that are outstanding. Credit cards that are due. But what if you only owe $40,000 in loans and credit cards? To make the equations match, you say that you have $60,000 in EQUITY. This is an intangible "calculated on the fly" subtraction of your liabilities from your assets.
QuickBooks even calculates this in two parts to help you see it more clearly. One part of this is the "Net Income". This is what - from your income and expense statement - QuickBooks has calculated you have earned for this year. Then, separately, it shows you the Retained Earnings value - which is "all the money you began with this year" that balances out the equation.
So to see this in a column format, let's say you have:
bank account 1: $40,000
bank account 2: $30,000
Equipment 1: $20,000
Equipment 2: $10,000
Total assets: $100,000
So far so good! Now you need to have the other side balance that. So it HAS to come out to $100,000.
So if you have:
Loan 1: $20,000
Credit card 1: $15,000
Credit card 2: $5,000
Total liabilities: $40,000
So far you are not balancing. You have $100,000 on one side and only $40,000 on the other side. So first QuickBooks looks at the current year and determines how much you've made in income, as part of that balance. That's your Net Income. So let's say that is $20,000.
Net Income: $20,000
Adding liabilities plus net income still only adds up to $60,000. You're still "missing" $40,000 to get this to balance to the $100,000 in assets. So QuickBooks reports that remaining $40,000 as your Retained Earnings. It is your equity in your company, the amount the company already had in its value at the beginning of the year.
