What Are Retained Earnings?
Retained earnings represent the total amount of net profits a business has held onto since it began operating. Instead of distributing all profits as dividends, companies may decide to retain some earnings for reinvestment, debt repayment, or growth.
- Increase: When your business earns a profit, retained earnings rise.
- Decrease: When you pay dividends to shareholders, retained earnings go down.
In short, retained earnings show how much of your company’s profit is being reinvested rather than distributed.
Where to Find Retained Earnings on the Balance Sheet
On your balance sheet, retained earnings are listed under the equity section, alongside shareholder equity or owner’s equity. In most cases, they do not appear on the income statement. Some businesses also prepare a separate statement of retained earnings each accounting period to track changes.
Retained Earnings Formula
The basic retained earnings calculation is:
Beginning Retained Earnings + Net Income (or Loss) – Dividends = Ending Retained Earnings
If you use accounting software, this is calculated automatically when generating your financial reports. For manual calculation, you’ll need:
- Beginning retained earnings (from the previous accounting period).
- Net income or net loss (from the income statement).
- Dividends distributed (cash or stock dividends paid to shareholders).
Example: Retained Earnings Calculation
Suppose your company starts in January with $0 retained earnings.
- January net income = $1,000
- No dividends issued
New retained earnings = $0 + $1,000 – $0 = $1,000
By February 1, your retained earnings balance will be $1,000.
Effect of Cash Dividends on Retained Earnings
If your company earns $10,000 in February and distributes $2,000 in cash dividends, the formula would be:
$1,000 (beginning retained earnings) + $10,000 (net income) – $2,000 (dividends) = $9,000 retained earnings
This reflects profit growth while accounting for shareholder payouts.
Effect of Stock Dividends on Retained Earnings
Sometimes businesses issue stock dividends instead of cash. This decreases retained earnings based on the fair market value (FMV) of the shares distributed.
Formula:
Current Retained Earnings + Net Income – (# of shares × FMV per share) = New Retained Earnings
Example:
- March net income = $10,000
- 5% stock dividend issued (500 shares at $10 FMV each = $5,000)
- Beginning retained earnings = $9,000
Calculation:
$9,000 + $10,000 – $5,000 = $14,000
Your retained earnings as of April 1 will be $14,000.
Retained Earnings vs. Shareholders’ Equity vs. Working Capital
- Shareholders’ Equity = Total Assets – Total Liabilities
- Retained Earnings are part of equity but specifically represent accumulated profits not paid out.
- Working Capital = Current Assets – Current Liabilities (measures liquidity and daily operating ability).
While related, each tells a different story about financial health.
Why Retained Earnings Matter for Investors
Potential investors and venture capitalists look at retained earnings to judge long-term financial stability. While net income shows short-term performance, retained earnings reflect how effectively profits have been managed and reinvested since the start of the business.
Keeping Financial Records Updated
Accurate and up-to-date financial records, including retained earnings, help identify cash flow trends early and support better decision-making. Modern bookkeeping services ensure that retained earnings and other key reports are always current.
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