Which statement correctly represents the relationship between retained earnings and net income?

The relationship between retained earnings and net income is fundamentally grounded in how a company's profitability impacts its equity. When a company earns net income, this amount is added to retained earnings, reflecting the accumulation of profits that have not been distributed to shareholders as dividends. Retained earnings represent the portion of net income that is retained in the business for reinvestment or to cover future liabilities, in contrast to amounts that may be paid out in dividends.

Thus, when net income is positive, it leads to an increase in retained earnings on the balance sheet. This demonstrates how effectively a company is retaining profits to foster growth or strengthen its financial position, making the connection between net income and retained earnings crucial for understanding a company’s equity and operational success.