What Are Retained Earnings?

Last Updated July 24, 2024

When it comes to your business balance sheet, one of the most important numbers you’ll find is your retained earnings, but to benefit from this information, you need to start by understanding how to calculate retained earnings and what they mean for your business.

Here’s a closer look at what retained earnings are and what they mean in terms of business accounting and the health of your company as a whole.

What Are Retained Earnings?

Retained earnings show a company’s net profits after all dividend payments have been accounted for. In other words, this number shows the earnings that were retained by the company to be saved for future use. This number can increase or decrease based on the level of profit that the company creates as well as how much it pays out in dividends to its shareholders.

The Purpose of Retained Earnings

Retained earnings are the funds that the company has decided to keep for its own purposes. They can be used to fund a wide variety of important activities, such as expanding existing operations, launching a new product, repaying outstanding debts, or even facilitating mergers and acquisitions.

By understanding the level of retained earnings available to the company, business leaders can make better informed cash flow management decisions and manage working capital more effectively.

For public companies, a strong history of retained earnings also demonstrates a stable financial position, making it more attractive to potential investors. This is particularly true when the earnings are able to generate additional returns.

Retained Earnings Formula

Retained earnings can be calculated using the following formula:

Retained Earnings = Beginning Period Retained Earnings + Net Income / Loss – Cash Dividends / Stock Dividends

It should be noted that you can use this same formula for how to calculate end-of-year earnings or for any other period you wish to measure.

How to Calculate Retained Earnings on a Balance Sheet

Let’s break down the specific steps for how you will calculate your business’s retained earnings for its balance sheet.

1. Note Your Beginning Retained Earnings

To start the process of calculating your retained earnings, you must first know your beginning (or beginning period) earnings. These should be reported on the previous period’s balance sheet. This could be from a quarterly balance sheet or even a year-end accounting report. Make sure to identify this information so you’ll know what your retained earnings were at the start of the current period.

For a brand-new business that doesn’t have any prior balance sheets, your beginning earnings will be zero. Keep in mind that they could also be negative from the previous period.

2. Add Your Net Income (or Net Loss) from the Current Period

Once you’ve noted your beginning retained earnings, you need to know how to calculate earnings with your assets and liabilities. By understanding how assets and liabilities influenced your business’s earnings during the current period, you’ll know how to calculate any additions to your earnings. You can use your profit and loss statement or cash flow statement if you need help determining your net income or net loss from the current period.

Retained earnings are impacted by the same factors that influence your net income. If your business received a cash infusion, paid down debt, earned sales revenue, or had other activities that affected its net income or net loss, that must be accounted for.

3. Subtract Cash Dividends and Stock Dividends

After you’ve added your net income or net loss to the beginning amount, you’ll need to subtract any cash or stock dividends that were distributed to shareholders during the same period. A cash dividend results in a cash outflow and reduces the company’s liquid assets, while stock dividend distributions transfer retained earnings to common stock.

The amount of dividends a company pays out is up to its ownership. Younger and more growth-focused companies often don’t pay out any dividends or only pay small amounts. Regardless of the amount you pay, you must deduct this amount from your total. Depending on the amount of dividends your company pays out, your retained earnings could be negative, even if it reported a profit.

4. Note Your Ending Retained Earnings

After these earlier calculations are complete, you have your ending retained earnings. This is the number that will go on the balance sheet for the current period. This number will also serve as your beginning figure for the next period’s balance sheet.

Example of Retained Earnings on a Balance Sheet

You can find retained earnings under the category of shareholder’s equity on your balance sheet. The total equity is equal to the amount left over after subtracting total liabilities from total assets.

Within the shareholder’s equity category in this example, most equity is held as common stock while a smaller portion remains as retained earnings. This equity, combined with the business’s total liabilities, is equal to its total assets.

What Retained Earnings Mean for Your Business

Retained earnings are a valuable measurement of your business’s profit after it has paid all direct and indirect costs, as well as taxes and dividends. This is the amount of money that your business has left over that can be used for additional investments in research and development or marketing, upgrading equipment, or other activities that could improve working capital or boost future opportunities for business success.

During periods of high growth, most companies prefer to have a higher level of retained earnings than dividend payouts. As a company matures and high growth is no longer as much of a priority, the allocation between dividends and these earnings often shifts in favor of dividend payouts.

Continued positive momentum in retained earnings ultimately signals a level of financial stability that will make your business more attractive to investors, while also ensuring you have enough funding to manage other growth activities.

How to Find Net Income with Your Retained Earnings and Dividends

While net income is often used to help calculate retained earnings, the formula also works in reverse. Here’s how to calculate net income with retained earnings and dividends:

Net Income = Retained Earnings – (Beginning Retained Earnings + Dividends)

With this formula, you have another solution for confirming your net income for the period you’re trying to measure.

In-Summary: Retained Earnings

As a form of shareholders’ equity, retained earnings are a valuable measurement of your business’s health. While they aren’t the be-all and end-all way to measure the financial strength of your company, they can assist in ensuring your business has additional financial resources that can be used to pay down debt or make other crucial investments.

There isn’t necessarily a one-size-fits-all answer for what the balance in equity should be between your retained earnings and dividends. However, newer and high-growth businesses tend to favor higher levels of retained earnings with low (or no) dividend payouts. A company that is consistently able to maintain profitable operations will generally see its figure grow over the years.

With a good level of retained earnings, a company can enjoy stability and consistent growth, since it has the financial resources needed to fund its activities. The ability to save for the future is a valuable asset for any business.

Retained Earnings FAQ

Where can I find retained earnings?

Look at the bottom of your business balance sheet. Retained earnings are listed under owner’s or shareholders’ equity, as they represent the company’s earnings after all dividends have been paid out.

Are retained earnings a debit or credit?

For business accounting purposes, retained earnings are considered a credit balance account. The amount is credited with additional profits and is debited as a result of losses or dividend distributions.

Are retained earnings an asset?

Retained earnings are not an asset. However, these funds can be used to purchase additional assets for the business, including equipment and inventory.

Are retained earnings equity?

Yes. Retained earnings are considered a type of owner’s or shareholders’ equity and are reported as such on the business balance sheet.

What does it mean when retained earnings are negative?

Negative retained earnings signify an accumulated deficit. In other words, the company’s operating costs and other investments have outweighed its net income during the period being measured. Negative earnings are relatively common with new businesses but can be a sign of financial trouble with more established companies and can also result from high dividend distribution.

What are appropriated retained earnings?

Appropriated retained earnings are those that have already been tagged for a specific use by the company’s board of directors. Common uses (or appropriations) include debt reduction, expansion activities, funding new product launches, and acquisitions.