How to Calculate Retained Earnings on a Balance Sheet

Calculating retained earnings is a fundamental skill that connects a company’s profitability with its overall financial position. This figure isn’t just a line item; it tells the story of how much cumulative profit has been plowed back into the business over its entire life. This article will show you exactly how to calculate retained earnings, explain why it matters, and clarify its place on your financial statements.

What Exactly Are Retained Earnings?

Retained earnings represent the portion of a company's net income that management has chosen to keep, rather than distribute to shareholders as dividends. Think of it as the company's long-term savings account, fueled exclusively by its own profits. Instead of cash, however, these "savings" are typically reinvested into the business through activities like:

• Purchasing new equipment or property to expand operations
• Funding research and development (R&D) for new products
• Paying down existing debt to strengthen the balance sheet
• Acquiring another company to drive growth

This balance accumulates over time, starting from the company's first day of business. It lives in the stockholders' equity section of the balance sheet and serves as a critical bridge between the income statement (where profit is generated) and the balance sheet (where the company's overall financial health is reported).

The Formula for Calculating Retained Earnings

The calculation itself is straightforward. You only need three pieces of information to determine the retained earnings balance for any given period. The formula is:

Ending Retained Earnings = Beginning Retained Earnings + Net Income (or - Net Loss) - Dividends Paid

Let's break down each component so you know exactly what they mean and where to find them.

1. Beginning Retained Earnings

This is the amount of retained earnings the company had at the start of the accounting period. It's simply the ending retained earnings balance from the previous period. You can find this number on the prior period's balance sheet under the stockholders' equity section. For a brand-new company, this figure will be zero.

2. Net Income (or Net Loss)

Net income is the company's profit for the current accounting period after all expenses, including taxes, have been paid. You'll find this on the "bottom line" of the company's income statement. If the company took a loss for the period, this number will be negative (a net loss), and it will decrease the retained earnings balance.

3. Dividends Paid

Dividends are payments made to shareholders, representing a distribution of the company’s profits. Because these payments send cash out of the business to its owners, they reduce the amount of profit that is retained and reinvested. You can typically find the total dividends paid during the period on the statement of cash flows or the statement of stockholders' equity. This includes both cash dividends and stock dividends.

A Step-by-Step Guide to Calculating Retained Earnings

With an understanding of the formula, let’s walk through the practical steps to perform the calculation. You'll need access to the company's balance sheet (from the prior period), its income statement (from the current period), and information on any dividends paid.

Step 1: Find Your Beginning Retained Earnings

Locate last period’s balance sheet. Under the "Stockholders' Equity" section, you’ll find a line item for "Retained Earnings." This is your starting point, or RE_beginning.

Step 2: Determine Your Current Period's Net Income (or Loss)

Pull up the income statement for the current period you are analyzing (e.g., quarter or year). The final number at the bottom, labeled "Net Income" or "Net Earnings," is the second piece of the puzzle.

Step 3: Identify Any Dividends Paid During the Period

Check the financing activities section of the statement of cash flows or the statement of stockholders' equity. This will show how much cash was paid out as dividends to shareholders during the period. Remember, dividends reduce retained earnings.

Step 4: Plug the Numbers into the Formula

Now, simply assemble the pieces using the formula: Beginning RE + Net Income - Dividends Paid.

Putting It All Together: A Practical Example

Let’s watch this in action with a fictional company, "Durable Goods Inc." We want to calculate their retained earnings for the year ending December 31, 2023.

• Step 1 (Beginning RE): We look at the balance sheet from December 31, 2022, and find the retained earnings balance was $250,000.
• Step 2 (Net Income): We review the income statement for the full year of 2023 and see that Durable Goods Inc. generated a net income of $110,000.
• Step 3 (Dividends): The statement of cash flows shows the company paid out $40,000 in dividends to its shareholders in 2023.

Now, we apply the formula:

Ending Retained Earnings = $250,000 + $110,000 - $40,000

Ending Retained Earnings = $320,000

The retained earnings balance for Durable Goods Inc. on their December 31, 2023 balance sheet will be $320,000. This $320,000 represents the total cumulative profit the company has reinvested back into itself since it started, after accounting for all dividends paid.

Where Retained Earnings Fit in Your Financial Statements

Retained earnings don’t exist in a vacuum. It’s part of a connected system of financial reporting. Here's how it links the key statements:

• Income Statement: The journey begins here. Net income is generated on the income statement, representing the new "fuel" for retained earnings.
• Statement of Retained Earnings: This statement explicitly shows our formula in action. It begins with the initial balance, adds net income from the income statement, subtracts dividends, and produces the final retained earnings number for the period.
• Balance Sheet: The final result from the statement of retained earnings flows directly into the stockholders' equity section of the balance sheet. It completes the accounting equation: Assets = Liabilities + Stockholders' Equity.

Common Sticking Points and Misconceptions

Even though the calculation is simple, a few misunderstandings about retained earnings persist. Clearing them up can help you better analyze a company's financial health.

Misconception #1: Retained earnings is a stash of cash.
This is the most common error. Retained earnings is an accounting entry on the balance sheet, not a bank account balance. The profits it represents have likely already been spent on tangible assets like new machinery, inventory, or R&D. The company’s actual cash balance is reported separately as a current asset.

Misconception #2: A high retained earnings balance is always a good sign.
While consistently positive retained earnings indicate long-term profitability, a very large and perpetually growing balance might be a red flag. It could suggest that management lacks new profitable investment opportunities, leading them to hoard capital instead of finding ways to generate higher returns for shareholders.

Misconception #3: Negative retained earnings means a company is bankrupt.
Negative retained earnings, often called an "accumulated deficit," signals that the company's cumulative losses and dividend payments have been greater than its cumulative profits. It's a serious indicator of poor financial performance, but it doesn't necessarily mean bankruptcy. The company could still have enough cash or assets to operate and may have a plan to return to profitability.

Final Thoughts

Calculating retained earnings connects a company’s income statement to its balance sheet, showing precisely how profitability contributes to its net worth. The formula — beginning balance plus net income minus dividends — is a cornerstone of financial accounting that tells the story of how successfully a business has reinvested for its future.

Accountants and finance teams must often advise on the tax consequences of using retained earnings to fund major business decisions, such as a large asset purchase or a change in entity structure. Getting fast, accurate answers for "what-if" scenarios is essential for sound guidance. When you require immediate, citation-backed answers to your tax questions, Feather AI provides instant clarity from authoritative sources, allowing you to focus on strategy and analysis instead of difficult research.