To calculate retained earnings on a balance sheet, take the beginning retained earnings from the previous accounting period, add net income or subtract net loss from the current period and subtract any dividend payouts. The remainder is the retained earnings for the current period. Retained earnings are often used by business owners for reinvestment in the company. The statement of retained earnings can be used to illustrate a company’s financial health.
What Are Retained Earnings?
Retained earnings are the cumulative profit or accumulated deficit of a company after paying all direct and indirect expenses, income taxes and stock dividend payments.
Unlike accounts in the income statement, which are temporary and subject to closure at the end of an accounting period, the account of retained earnings is a permanent account. Companies must use the retained earnings from the previous year to calculate the retained earnings in the new balance sheet.
The ending retained earnings from the prior period become the beginning retained earnings balance for the next period. Income and distribution during the year are added to and subtracted from the beginning balance to arrive at the end balance of current retained earnings.
Retained earnings are part of stockholder’s equity, or the total claim on a business that all shareholders have after every company debt has been settled. According to the Corporate Finance Institute, one way to calculate stockholder’s equity is to combine the total retained earnings with the revenue or loss due to new stock sold or treasury stock repurchased.
What Increases or Decreases Retained Earnings?
Retained earnings are affected by revenue that flows into the business through sales and investments and any outflows related to operating expenses, cost of goods sold and depreciation of assets. Any credits or debits that impact net income will eventually impact retained earnings. The total amount of dividend payments distributed to shareholders will also impact retained earnings.
Where to Find Retained Earnings on Financial Statements
The retained earnings account appears in the equity section of the balance sheet under the shareholder’s equity section because it is a type of equity in the business rather than an asset.
Funds in the retained earnings account can be used for capital expenditures, such as asset purchases, business expansion, new product launches or the payment of additional cash dividends or business debts. While the resources held as retained earnings can be used for working capital, they appear as a liability on financial statements.
Retained earnings are found near the bottom line of the income statement because they are what is left of net income after shareholders are paid. When retained earnings are growing consistently, that points to a healthy bottom line.
The Statement of Retained Earnings
Germanna Community College explains that the statement of retained earnings outlines the changes in a company’s accumulated profit during a particular accounting period. It shows how much money the business has left to grow and expand.
In conjunction with a company’s other financial statements, such as the balance sheet, income statement and statement of cash flows, the statement of retained earnings can be used by investors and lenders to get a clear picture of a business’s financial health.
What Is the Retained Earnings Formula?
To calculate retained earnings, you'll need to know the beginning period retained earnings, the total net income or loss during the accounting period and the total amount of dividends paid out.
If a small business begins with retained earnings of $10,000 and has a net income of $15,000 during the accounting period, paid out $2,500 in cash dividends and $2,500 in stock dividends, the equation is:
$10,000 + $15,00 - $2,500 - $2,500 = $20,000
The ending retained earnings of the period equal $20,000.
What Is the Retention Ratio Formula?
The retention ratio shows what percentage of net income is kept by a business after dividend payments, explains CFI.
In the example above, the small business's net income was $15,000, and all dividend payments totaled $5,000. The calculation for retention ratio for that business would be:
($15,000 - $5,000) ÷ $15,000 = 0.67
In this case, the business retains 67 percent of its net income for reinvestment into the business. This metric can help a company or investors define trends in a company’s growth over time.
Common Questions About Retained Earnings
What Is the Difference Between Retained Earnings and Net Income?
Net income or net profit is the amount of revenue a business has after paying its operating expenses, cost of goods, interest and taxes. Retained earnings take it a step further by also taking out the cost of dividend payouts. The two metrics are different but interconnected.
Can a Company Have Negative Retained Earnings?
A company could have negative retained earnings if the net loss was more than the beginning period retained earnings. For instance, if a company begins with $10,000 in retained earnings and has a net loss of $15,000 for that accounting period, retained earnings will appear as -$5,000.
Melissa is a writer and editor from Chicago, with a background in small business ownership. After selling her business, she moved into marketing for nonprofits and now manages volunteers at a large medical association. She is a writing and editing contractor and contributed to dozens of blogs and websites.