How to Calculate Ending Retained Earnings

Retained earnings represent the portion of a company’s cumulative net income that has been kept within the business rather than distributed to shareholders as dividends. This accumulated profit serves as a significant indicator of a company’s financial strength and its capacity to reinvest in its operations. By retaining earnings, a business can fund future growth initiatives, pay down debt, or acquire new assets, which helps sustain long-term stability and expansion.

Understanding Retained Earnings

Retained earnings are a crucial component of a company’s stockholders’ equity, appearing on the balance sheet. Unlike a cash balance, which represents liquid assets, retained earnings reflect the cumulative profits that have been reinvested into the business or used to reduce liabilities. This account showcases how much of a company’s historical earnings have been “retained” and are not available for distribution to owners. It signifies the ownership claim against the company’s assets that arises from its past profitability.

The balance in retained earnings is a running total, accumulating profits over the company’s entire operational history. A growing retained earnings balance often indicates financial health and a disciplined approach to reinvestment. This allows the company to build its asset base and strengthen its overall financial position without relying solely on external financing.

Key Components for Calculation

Calculating the ending balance of retained earnings requires three specific pieces of financial information.

Beginning Retained Earnings

Beginning retained earnings refers to the balance of retained earnings at the start of an accounting period. This figure represents the accumulated profits from all prior periods that the company had not distributed as dividends up to that point. Typically, this amount is directly found on the balance sheet from the immediately preceding accounting period. For example, the ending retained earnings from the previous fiscal year become the beginning retained earnings for the current fiscal year.

Net Income (or Loss)

Net income, or net loss, represents the total profit or deficit a company generates during the current accounting period. This figure is derived directly from the company’s income statement. Net income increases the retained earnings balance, reflecting the addition of current period profits to the accumulated earnings. Conversely, a net loss decreases retained earnings, as the company’s operations resulted in a reduction of its overall accumulated profit. Net income is calculated after all expenses, including operating costs, interest, and income taxes, have been deducted from revenues.

Dividends Declared

Dividends declared represent the portion of a company’s profits that its board of directors formally decides to distribute to shareholders. These distributions directly reduce the retained earnings balance because they represent a payout of accumulated earnings to the owners. Information regarding dividends declared can typically be found in the statement of cash flows, specifically within the financing activities section, or in the statement of stockholders’ equity.

Steps to Calculate End Retained Earnings

Calculating the ending retained earnings balance involves a straightforward application of a specific financial formula. This calculation aggregates the accumulated profits from previous periods, adjusts for current period performance, and accounts for shareholder distributions. The core formula used to determine this figure is: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings.

To apply this formula, you first identify the beginning retained earnings balance, which is the ending balance from the previous period’s balance sheet. Next, obtain the net income or net loss figure from the current period’s income statement. If the company experienced a net loss, this amount will be subtracted from the beginning retained earnings. Finally, determine the total amount of dividends declared and paid to shareholders during the current period, which will reduce the retained earnings.

Assume a company had beginning retained earnings of $500,000 at the start of its fiscal year. During that same year, the company generated a net income of $150,000 from its operations. Additionally, the company’s board of directors declared and paid $50,000 in cash dividends to its shareholders.

Using the formula, you would take the $500,000 beginning retained earnings and add the $150,000 net income. From this sum, you then subtract the $50,000 in dividends declared. The calculation would be $500,000 + $150,000 – $50,000, resulting in an ending retained earnings balance of $600,000. This newly calculated ending retained earnings figure is then reported on the current period’s balance sheet, specifically within the equity section.