How to Calculate Change in Retained Earnings

Retained earnings represent the portion of a company’s cumulative net income that has not been distributed to its shareholders as dividends. This figure is a component of owner’s equity, which is reported on a company’s balance sheet, providing insight into how much profit a company has accumulated over time. Retained earnings reflect the profits a company has saved and reinvested into its operations or reserved for future use.

Understanding the Components

Calculating the change in retained earnings requires identifying three specific financial figures. These components are typically found in a company’s financial statements. Understanding what each component represents is important before performing any calculations.

Beginning Retained Earnings

The first component is Beginning Retained Earnings, which is the retained earnings balance from the close of the previous accounting period. This figure represents the cumulative profits that the company had retained up to the start of the current period. You can locate this amount on the prior period’s balance sheet within the shareholders’ equity section.

Net Income or Net Loss

The next component is Net Income or Net Loss for the current accounting period. Net income is the profit a company earns after all expenses, including taxes, have been deducted from its revenues. Conversely, a net loss occurs when expenses exceed revenues. This figure is typically found at the bottom of the company’s income statement and directly impacts retained earnings; net income increases them, while a net loss decreases them.

Dividends Declared

The final component is Dividends Declared, which are distributions of a company’s profits to its shareholders. These payments reduce the amount of earnings that a company keeps. Dividends can be paid in cash or sometimes as additional shares, and they directly decrease the retained earnings balance. Information about dividends can usually be found in the company’s financial records or its statement of cash flows.

Performing the Calculation

The calculation for the change in retained earnings connects the beginning balance with the current period’s profitability and distributions to shareholders. The formula is: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings.

To apply this formula, identify the beginning retained earnings balance from the previous period’s balance sheet. Then, add the net income for the current period, which is obtained from the income statement, or subtract a net loss if the company incurred one. Finally, deduct any dividends that were paid out to shareholders during the period.

For example, consider a company that started the year with $500,000 in retained earnings. During the current year, the company generated a net income of $150,000 and paid out $50,000 in dividends to its shareholders. Using the formula, the calculation would be $500,000 (Beginning Retained Earnings) + $150,000 (Net Income) – $50,000 (Dividends) = $600,000 (Ending Retained Earnings). This shows a positive change, indicating the company retained more earnings than it distributed.

If, instead, the company had a net loss of $20,000 and paid $30,000 in dividends, the calculation would be $500,000 (Beginning Retained Earnings) – $20,000 (Net Loss) – $30,000 (Dividends) = $450,000 (Ending Retained Earnings). This scenario results in a decrease in retained earnings. The ending balance from one period then becomes the beginning balance for the subsequent period, creating a continuous link between accounting periods.

Interpreting the Result

The ending retained earnings balance offers valuable insights into a company’s financial decisions and performance. A positive change indicates that the company generated profits and chose to retain a portion of those earnings within the business. This suggests the company is building its internal capital, which can be used for various strategic purposes.

Conversely, a negative change, or a lower ending balance, could signify either a net loss for the period or significant dividend payouts that exceeded the current period’s earnings. While a net loss directly reduces retained earnings, substantial dividends might also reflect a company’s policy to return profits to shareholders, even if it means drawing down accumulated earnings.

Retained earnings are a measure of a company’s financial health and its capacity to fund future growth or operations without relying solely on external financing. Companies often use these accumulated funds to reinvest in the business, such as purchasing new equipment, expanding operations, funding research and development, or reducing debt. A strong retained earnings figure indicates a company’s ability to sustain operations and pursue strategic initiatives, contributing to its long-term stability and value.