Are Retained Earnings and Net Income the Same?

Net income and retained earnings are fundamentally linked but are not the same. Net income measures profitability over a specific period, such as a quarter or a year. Retained earnings, in contrast, represent the cumulative profits a company has kept over its entire existence, after accounting for any distributions to shareholders. Understanding the distinction is a matter of looking at a single period’s performance versus the accumulated results over a company’s history.

Defining Net Income

Net income is a measure of a company’s profitability and is often referred to as the “bottom line” of a financial report. This figure represents the profit remaining after all operating expenses, interest, and taxes have been subtracted from total revenues for a specific accounting period. The calculation is: Revenues – Expenses = Net Income.

This figure is located on a company’s Income Statement. The income statement provides a summary of how the business incurred its revenues and expenses over a specific interval. Think of it like a personal monthly budget where you subtract all your spending, from rent to groceries, from your total monthly pay to see what’s left. A positive net income shows that revenues exceeded expenses, indicating profitability for that period.

Defining Retained Earnings

Retained earnings are the portion of a company’s net income that management reinvests in the business instead of paying out to shareholders as dividends. This figure represents the sum of all past profits kept by the company. It is a cumulative amount that grows over time as the business generates and retains more income.

This account is a component of the Shareholders’ Equity section on the company’s Balance Sheet. The balance sheet is a snapshot of the company’s financial position at a single point in time. It shows what a company owns (assets), what it owes (liabilities), and the owners’ stake (shareholders’ equity). Retained earnings contribute to this equity, reflecting the capital generated internally to fund growth.

The Connection Between Net Income and Retained Earnings

The link between these two metrics is detailed on the Statement of Retained Earnings. Net income is a primary input for determining the period-end retained earnings balance. The process begins with the prior period’s retained earnings, adds the current period’s net income, and subtracts any dividends paid to shareholders.

The formula is: Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings. This ending balance then appears on the balance sheet for the current period. For example, a company starts the year with $200,000 in retained earnings. During the year, it generates a net income of $75,000 and distributes $25,000 in dividends.

The calculation would be $200,000 + $75,000 – $25,000, resulting in an ending retained earnings balance of $250,000. This new, higher balance signifies that the company has increased its internally generated capital, which can be used to pay down debt, purchase new assets, or fund other initiatives. This flow demonstrates how profitability from one period directly increases the cumulative equity of the business.