How to calculate retained earnings: formula, examples, and importance

Though you’ll find them recorded on the ‘liability’ side of your balance sheet, retained earnings are actually a key indicator of your business’s sound financial standing. You can think of them as the company’s private piggy bank—a place to store everything left over from net income after paying dividends. 

Understanding what retained earnings represent and how to find them not only helps you manage finances effectively day-to-day; it also gives you a big-picture view of when the business can afford to spend (and when it should cut back). In this guide we’ll cover everything from how to calculate retained earnings to how to interpret them on different financial documents. 

What are retained earnings? 

Retained earnings are the portion of a company’s net earnings that the company decides to hold as a reserve or reinvest in its own growth rather than issue as dividends in cash or shares to reward shareholders. They’re an important measure of value held within the business. But they aren’t an asset, so you’ll find them recorded as ‘equity’ on a company balance sheet. 

Typically, increases in profits lead to increases in retained earnings, as the company has more money to set aside. A net loss likewise can reduce a company’s retained earnings, as can dividends payments. 

Businesses can use retained earnings for everything from purchasing equipment to increasing headcount to rewarding shareholders. A company with healthy retained earnings might decide to:

• Fund expansion. In order to grow, businesses need to invest in tools, technology, equipment, and personnel that support key initiatives. 
• Distribute dividends. Companies that issue shares may opt to compensate shareholders with payments in the form of cash or stock.
• Paying off existing debts. In some cases, it may make financial sense for a company to use retained earnings to completely discharge an obligation, such as a high-interest, short-term loan.

Reviewing a business’ retained earnings over time can also help a potential investor understand its priorities and give a glimpse into its operations. If a company continues to report increased retained earnings while competitors struggle in unfavorable economic conditions, for example, you might feel confident that leadership made sound financial decisions to maximize efficiency and cash reserves.

The retained earnings formula

Taken together and expressed in a straightforward formula, retained earnings looks like this:

Beginning retained earnings + Net income - Dividends = Retained earnings

To understand the formula, it can help to remember what retained earnings represent: the earnings a company chooses to set aside over time rather than paying it out to shareholders. So, you start with what the company already held back, add in any new earnings, and then subtract any new dividend payouts. 

1. Beginning period retained earnings 

This number, which you’ll find on the balance sheet for the previous period, represents the company’s cumulative retained earnings up to the starting point of your calculation. 

• Example: Acme Corp. recorded retained earnings of $80,000 on September 30, 2024. To calculate retained earnings for the fourth quarter, you’ll start with the $80,000 accumulated up to October 1, 2024.

2. Net income/net loss during an accounting period 

Net income and net loss represent the business’s overall financial performance during a specific period. Companies operating efficiently and generating revenue usually report gains on their income statements. (Note that some companies refer to an income statement as a profit and loss statement.)

Companies that don’t perform as well or have taken a strategic decision may report a net loss. 

• Example: Acme Corp. recorded a net income of $150,000 in the fourth quarter. Assuming the company doesn’t pay dividends, its total retained earnings for Q4 will amount to $230,000.

Be careful not to confuse net income with gross income. Gross income refers to the business’ total revenues before deducting expenses, servicing debt, paying employees, and other mandatory payments. Net income is what’s left over after the business has met its obligations. 

3. Cash and stock dividends 

When a business decides to distribute some of its earnings to shareholders, it issues dividends in the form of either cash payments or shares of stock. Dividends are paid out of accumulated retained earnings, so you’ll need to subtract them from the sum of net income and beginning retained earnings to find the total for your defined period. 

• Example: Acme Corp. issued dividends to shareholders valued at $75,000 in the month of November. To find the total retained earnings for the fourth quarter, you’ll subtract the $75,000 in dividends from $230,000.

Note that if a business decides to pay dividends in cash and stock, you’ll calculate the value of each separately and then add them together before subtracting the total from net income and beginning retained earnings.

• Example: Acme Corp.’s Class A shareholders received cash dividends worth $25,000. Class B shareholders, however, received stock worth $50,000. Acme Corp. therefore issued $75,000 in dividends for the quarter.

How to calculate retained earnings: 3 steps 

While you might need to refer to multiple financial documents, the process of calculating retained earnings is generally straightforward. Just be sure you have your company’s most recent balance sheet and income statement ready before you begin.

Step 1. Define retained earnings beginning balance 

Retained earnings are cumulative, which means earnings from the previous period carry over to the next. The starting point for your calculation, therefore, is the total retained earnings from the previous period. You can find this on the balance sheet for the corresponding period in the ‘Equity’ section.

Beginning Retained Earnings = $150,000

Step 2. Add the net income/loss for the current period 

Theoretically, all the income a business generated in the defined period could be retained earnings if the company decided not to reinvest or pay dividends. So, the second step is to review the company's income statement for either income or losses.

In the case that the company reported net income, you’ll add this number to the previous period’s retained earnings. If the company reported a loss, you’ll subtract instead.

Beginning Retained Earnings = $150,000

Net Income = + $50,000

Step 3. Subtract any dividends paid out of that net income 

If the company chose to issue dividends during the defined period, you’ll subtract the total amount from the sum of the beginning retained earnings and the net income (or the difference between retained earnings and a net loss). 

Beginning Retained Earnings = $150,000

Net Income = + $50,000

Dividends = -$75,000

Retained Earnings = $125,000

2 examples of retained earnings calculation 

To better understand how to find retained earnings, let’s consider two examples. In one case, the company reports a positive net income, while in the other it experiences a loss.

Example 1: Widgets, Inc. reported retained earnings of $600,000 in 2022. In 2023, the company’s income statement showed net earnings of $150,000. Based on its successful year, the company decides to issue dividends to shareholders worth $100,000.

$600,000 + $150,000 - $100,000 = $650,000

Example 2: Things take a turn for  Widgets, Inc. in 2024, and business drops off. The company reports a net loss of $75,000 and does not issue dividends. 

$650,000 - $75,000 = $575,000

How to prepare a retained earnings statement

A retained earnings statement works like a snapshot of a company’s activity over a specific accounting period, showing how the business decided to reinvest profits or distribute dividends to shareholders. It complements the income statement, and you’ll find the final result recorded in the ‘equity’ section of the balance sheet.

Step 1. Create a statement heading 

The statement heading spells out the essential details anyone reading will need to know to interpret information correctly. Title your document “Retained Earnings Statement” and include the company name and accounting period.

Step 2. Define the beginning period of retained earnings 

Start by identifying the start date for your reporting period. The retained earnings on that date form the foundation of your calculation. If you’re calculating on an annual basis, for example, refer to the previous year’s balance sheet.

 Step 3. Add net income from the income statement 

You’ll find your business’s net income (or net loss) on the company’s most recent income statement. Note that, while in Step 2 you referred to last year’s  balance sheet, for this portion of the exercise you’ll need the current year’s income statement. 

If the company reported an increase in the form of net income, add this number to the previous year’s retained earnings. If the company instead reported a net loss, subtract the loss.

Step 4. Subtract dividends paid to investors 

If the company paid out dividends to investors, record the total amount disbursed. To find the final retained earnings, you’ll subtract this number from your final calculation  in Step 3. 

How to interpret retained earnings

Depending on your goals, you can look at retained earnings in a few different ways to gain insight into a company’s overall financial health.  Because they reflect how a business balances growth, reinvestment, and shareholder needs, you can use this number to better understand its overall approach to managing capital and assess its long-term strategy.

1. Company life cycle 

In a company's lifecycle, startups and high-growth companies typically have lower retained earnings because they prioritize investing in tools, technology, and people needed to scale quickly. More mature companies with stable profits will tend to have higher retained earnings. 

2. Dividend policy 

High retained earnings with minimal dividends suggest a focus on reinvestment. On the other hand, low retained earnings and larger dividend payouts point to a policy that favors keeping shareholders happy. 

3. Profit margins 

Take a look at the overall trend in retained earnings for an idea of how well a company performs financially. An upward curve as the business grows usually signals wise investment and operational efficiency. A flat line or a downward curve could be a sign that the company needs help managing its operations or cash flows. 

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Retained earnings calculation FAQs

How to calculate retained earnings on a balance sheet?

To calculate retained earnings on a balance sheet, first find the retained earnings from the previous financial period. Next, review the income statement and add any net income or subtract any net losses. Finally, subtract any dividends paid. 

What are the limitations of retained earnings? 

Limitations of retained earnings as a financial metric include the inability to reflect liquidity, current profitability, or operational efficiency. A business with substantial cash reserves might seem healthy on paper, for example, but need more support in production because leadership prefers to hold on to the earnings rather than invest resources in essential processes.  

How to calculate the effect of a cash dividend on retained earnings?

To calculate the effect of a cash dividend on retained earnings, subtract the dividend amount from the company’s cumulative retained earnings. 

What is the difference between retained earnings and revenue?

The difference between retained earnings and revenue lies in their purpose and how a business records them. Revenue represents the total income generated by the business, while retained earnings stand for funds held in reserve by the business after paying dividends. Revenue appears on the top line of a company’s income statement, while retained earnings are recorded as equity on the balance sheet.

Are retained earnings an asset?

No, retained earnings are not an asset. They represent the portion of net income that the business re-invests in the company or holds as a reserve and are recorded as equity on its balance sheet.

This blog is based on information available to Rippling as of November 25, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.