How Do You Calculate Retained Earnings?

Retained earnings represent the accumulated net income of a company that has not been distributed to its shareholders as dividends. These earnings are kept within the business for reinvestment or to strengthen its financial position. A company’s ability to retain earnings often indicates its financial health and its capacity to fund future growth initiatives. Understanding how to calculate retained earnings provides insight into a company’s past profitability and its strategy for future development.

Understanding the Components

Calculating retained earnings requires a clear understanding of three primary financial figures. These components are found on a company’s financial statements and provide the necessary inputs for the calculation.

Beginning Retained Earnings

Beginning retained earnings refers to the retained earnings balance from the end of the previous accounting period. Companies typically report this balance on their Statement of Retained Earnings or within the Shareholders’ Equity section of the Balance Sheet from the prior period.

Net Income

Net income, or net loss, represents the total profit or loss generated by the company during the current accounting period. This figure is derived after all expenses, including taxes, have been deducted from revenues. The net income or net loss can be found at the bottom line of the company’s Income Statement for the current period.

Dividends

Dividends are the portions of a company’s profits that are distributed to its shareholders. For the purpose of calculating retained earnings, only dividends that have been formally declared and paid during the current accounting period are relevant. Information regarding dividends paid can often be located on the Statement of Retained Earnings or the Statement of Cash Flows.

The Retained Earnings Formula

The calculation of retained earnings involves a straightforward formula that connects a company’s past accumulated profits with its current financial performance and distributions. This formula allows businesses to determine the precise amount of earnings kept within the company at the end of an accounting period.

The standard formula for calculating ending retained earnings is: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings. Net income is added to the beginning balance because it represents the profit generated during the current period, which increases the total earnings available to the company.

Conversely, if a company incurs a net loss, this amount is subtracted from the beginning retained earnings, as it reduces the company’s overall accumulated profits. Dividends paid to shareholders are also subtracted from the total. These distributions reduce the amount of earnings that the company keeps for reinvestment or other internal uses.

Applying the Formula: A Step-by-Step Example

To illustrate the calculation, consider a hypothetical company, “ABC Corp.,” at the end of its fiscal year. At the start of the year, ABC Corp. had a beginning retained earnings balance of $150,000. This figure was carried over from the close of the previous fiscal period.

During the current fiscal year, ABC Corp. reported a net income of $75,000 from its operations. This positive net income indicates that the company generated more revenue than it incurred in expenses for the period. The company also declared and paid $20,000 in cash dividends to its shareholders.

To calculate the ending retained earnings for ABC Corp., we apply the formula: Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings. Plugging in the figures, we have $150,000 (Beginning Retained Earnings) + $75,000 (Net Income) – $20,000 (Dividends).

Performing the calculation, $150,000 plus $75,000 equals $225,000. Subtracting the $20,000 in dividends results in an ending retained earnings balance of $205,000. This final figure represents the total accumulated earnings that ABC Corp. has retained within the business at the close of the current fiscal year, available for future investment or other corporate purposes.