How to Calculate Ending Balance of Retained Earnings

Retained earnings represent the accumulated profits of a business that have not been distributed to its shareholders as dividends. This figure provides valuable insight into a company’s ability to generate and retain profits over time, which can be used to fund future growth, pay down debt, or build financial reserves. Understanding how to calculate retained earnings is fundamental for assessing a business’s financial health and its potential for long-term sustainability. It serves as a bridge between a company’s income statement and its balance sheet, reflecting the cumulative financial success that a business has preserved for its operations and future endeavors.

Key Elements of Retained Earnings

To calculate retained earnings accurately, it is important to understand the three primary components that influence this balance. The starting point for any period’s calculation is the beginning retained earnings, which is simply the ending balance from the previous accounting period.

Net income, or net loss, is the next significant element. This figure, derived from the income statement, represents a company’s profitability over a specific period, calculated as total revenues minus all expenses, including taxes. A positive net income increases retained earnings, while a net loss decreases this balance.

Dividends are the third component, representing distributions of a company’s profits to its shareholders. These payouts reduce the retained earnings balance because they are funds being distributed out of the company, rather than being reinvested. Dividends can be issued in various forms, such as cash or additional shares of stock, and both types decrease the amount of earnings a company retains.

The Retained Earnings Formula

The standard formula for calculating the ending balance of retained earnings combines these three elements in a straightforward mathematical relationship. It begins with the retained earnings balance from the start of the period. To this amount, the company’s net income for the current period is added, or its net loss is subtracted. Finally, any dividends paid out to shareholders during the period are subtracted.

This formula can be expressed as: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings. The calculation clearly shows how a company’s profitability and its decisions regarding shareholder distributions directly impact the amount of earnings it retains for future use.

Applying the Calculation

Calculating the ending balance of retained earnings involves a direct application of the formula using specific financial figures. For instance, consider a business that started the year with a retained earnings balance of $150,000. During the year, this company generated a net income of $75,000. Subsequently, the company distributed $25,000 in dividends to its shareholders.

To determine the ending retained earnings, one would take the beginning balance of $150,000, add the net income of $75,000, and then subtract the dividends of $25,000. This calculation results in an ending retained earnings balance of $200,000 ($150,000 + $75,000 – $25,000). This outcome indicates that the company’s retained earnings grew over the period, signifying an increase in the accumulated profits available for reinvestment or other company purposes.

In a scenario where a company experiences a net loss instead of a net income, the calculation adjusts accordingly. If the same company had a beginning retained earnings of $150,000 but incurred a net loss of $30,000 and still paid $10,000 in dividends, the calculation would be $150,000 – $30,000 – $10,000, resulting in an ending balance of $110,000. This demonstrates how a net loss, like dividends, reduces the accumulated earnings available to the business.