How to Calculate Accumulated Retained Earnings
Unlock insights into a company's financial strength by understanding how its undistributed profits fuel future growth and stability.
Retained earnings represent the portion of a company’s accumulated net income that has not been distributed to its shareholders as dividends. These earnings are kept within the business for reinvestment, to fund growth opportunities, or to pay down debt. This figure offers insight into a company’s financial health and its capacity for future expansion without relying on external financing. Businesses use retained earnings for purposes such as purchasing new equipment, investing in research and development, or expanding operations.
Key Components of Retained Earnings
Calculating retained earnings involves three financial figures. The first is Beginning Retained Earnings, the accumulated balance of profits held by the company at the close of the previous accounting period. This amount serves as the starting point for the current period’s calculation, representing the earnings carried over from prior years.
The second component is Net Income (or Loss). Net income signifies the profit a company generates after accounting for all revenues and subtracting all expenses, including taxes. A net profit increases retained earnings, while a net loss reduces them.
Finally, Dividends Declared are the third component. Dividends represent the portion of profits a company’s board of directors decides to distribute to shareholders. These distributions directly reduce the amount of earnings retained by the company.
The Retained Earnings Formula
The calculation of retained earnings follows a standard formula. This formula begins with the prior period’s retained earnings balance. It then adjusts this amount by adding the net income or subtracting any net loss incurred during the current accounting period.
From this adjusted figure, any dividends declared are subtracted. The result is the ending retained earnings balance for the current period. This ending balance then becomes the beginning retained earnings for the subsequent accounting period.
Step-by-Step Calculation Example
To illustrate the calculation, consider a hypothetical company, “Growth Corp.” At the beginning of its fiscal year, Growth Corp. had a retained earnings balance of $500,000.
During the current fiscal year, Growth Corp. generated a net income of $150,000. Subsequently, the company’s board of directors decided to declare $40,000 in dividends.
To calculate Growth Corp.’s ending retained earnings, start with the beginning balance of $500,000. Add the net income of $150,000. Then, subtract the $40,000 in dividends. The resulting ending retained earnings balance for Growth Corp. is $610,000.
Sources of Financial Information
To calculate retained earnings, you need to locate the necessary figures on a company’s financial statements. The Net Income figure is found on the Income Statement, often referred to as the “bottom line” because it is the final result after all revenues and expenses are considered. This statement summarizes a company’s financial performance over a period, such as a quarter or a year.
Dividends Declared are typically reported on the Statement of Retained Earnings or the Statement of Shareholder’s Equity. While dividends are not an expense and do not appear on the income statement, their declaration reduces retained earnings, and details of these distributions are shown on these equity-related statements. Dividends paid are also reflected in the financing activities section of the Statement of Cash Flows.
The Beginning Retained Earnings balance can be found on the company’s Balance Sheet from the previous accounting period, specifically within the Shareholder’s Equity section. It can also be found as the ending balance on the prior year’s Statement of Retained Earnings.