How to Calculate Retained Earnings: Formula and Example

Retained earnings represent the portion of a company’s accumulated profit kept within the business rather than paid out to shareholders as dividends. This metric indicates how much profit a company has saved over time. It is a key figure for assessing a business’s financial health and its capacity for future growth and investment.

Understanding the Core Components

Calculating retained earnings involves understanding three specific financial figures. The first is the prior period’s retained earnings, which serves as the starting point because retained earnings accumulate over a company’s lifespan. This figure from the end of the previous accounting period becomes the beginning balance for the current period.

The second component is net income, or net loss, which reflects a company’s profitability during an accounting period. Net income is the profit remaining after all expenses, including taxes, have been deducted from revenue. A positive net income increases retained earnings, while a net loss decreases them.

Finally, dividends are the third component. These are payments a company makes from its profits to shareholders. Dividends reduce the amount of earnings a company retains.

The Calculation Method

The calculation of retained earnings follows a formula combining the previously discussed components. To determine the ending retained earnings for a period, begin with the retained earnings from the start of that period. Then, add the net income (or subtract the net loss) generated during the current period and subtract any dividends.

The formula is: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings. For example, Alpha Corp started the year with $150,000 in retained earnings. During the year, Alpha Corp achieved a net income of $75,000 and paid out $25,000 in dividends to its shareholders. Applying the formula, Alpha Corp’s ending retained earnings would be calculated as: $150,000 (Beginning Retained Earnings) + $75,000 (Net Income) – $25,000 (Dividends) = $200,000 (Ending Retained Earnings).

Interpreting the Figure

A positive retained earnings balance indicates a company has accumulated profits reinvested in the business rather than distributed to shareholders. This shows financial health and a capacity for internal funding of growth initiatives. Companies can use these accumulated funds for purposes such as investing in new equipment, expanding operations, or paying down debt.

Conversely, a negative retained earnings balance, often called an “accumulated deficit,” indicates a company has incurred more losses than profits or distributed more in dividends than it has earned. While common for young, growing companies that are heavily investing, a persistent accumulated deficit can signal financial distress. It implies the company has not been profitable enough to cover its past losses and dividend payouts.