How to Calculate Retained Earnings: Formula and Steps
Calculate retained earnings with ease. This guide offers a clear formula and practical steps to understand your business's accumulated reinvested profits.
Retained earnings represent the cumulative net profits a company has accumulated after distributing dividends to shareholders. These earnings are reinvested into the business, serving as an internal source of funding. Companies often utilize retained earnings to finance growth initiatives, repay debt obligations, or invest in new equipment and research and development. Understanding how to calculate retained earnings provides insight into a company’s financial health and its capacity for future expansion without external financing.
Understanding the Key Components
Calculating retained earnings involves three primary financial components. Beginning retained earnings represent the accumulated profits from all prior accounting periods carried forward to the start of the current period.
Net income, or net loss, is the second component and signifies the company’s profitability during a specific accounting period. This figure is derived after all revenues and gains have been accounted for and all expenses and losses, including taxes, have been subtracted. A positive net income increases retained earnings, while a net loss reduces them.
The third component involves dividends, which are distributions of a company’s profits to its shareholders. Dividends reduce the amount of earnings retained by the company.
The Retained Earnings Formula
The standard formula for calculating ending retained earnings for a given period combines these three elements. It begins with the company’s beginning retained earnings balance. To this amount, the net income (or net loss) for the current period is added or subtracted. Finally, any dividends distributed to shareholders during the period are subtracted from this sum.
The formula can be expressed as: Ending Retained Earnings = Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends. This calculation illustrates how a company’s accumulated profits change over time, reflecting both its operational performance and its distribution policies.
Step-by-Step Calculation Example
To illustrate the calculation, consider a hypothetical company, “Innovate Corp.” At the beginning of the fiscal year, Innovate Corp. had a retained earnings balance of $500,000.
During the current fiscal year, Innovate Corp. generated a net income of $150,000. This profit increased the company’s overall earnings available for retention. Following a successful year, the board of directors decided to distribute $40,000 in dividends to its shareholders.
To calculate the ending retained earnings, we apply the formula: Beginning Retained Earnings + Net Income – Dividends. Plugging in the numbers, this becomes $500,000 (Beginning Retained Earnings) + $150,000 (Net Income) – $40,000 (Dividends). The sum of $500,000 and $150,000 is $650,000. Subtracting the $40,000 in dividends results in an ending retained earnings balance of $610,000. This final amount reflects the portion of earnings Innovate Corp. has chosen to keep and reinvest at the end of the period.
Locating the Necessary Financial Data
To perform the retained earnings calculation, financial data must be retrieved from a company’s financial statements. The beginning retained earnings balance is typically found on the company’s balance sheet under the shareholders’ equity section from the previous accounting period. This figure may also be presented on a Statement of Retained Earnings or a Statement of Stockholders’ Equity.
Net income or net loss for the current period is readily available on the company’s income statement. This statement summarizes a company’s revenues and expenses over a specific period.
Information regarding dividends paid can be located in several places. Dividends declared and paid are reported as a cash outflow within the financing activities section of the Statement of Cash Flows. They are also explicitly noted as a subtraction from retained earnings on the Statement of Retained Earnings or Statement of Stockholders’ Equity. While dividends do not appear on the income statement, dividends declared but not yet paid may be listed as a liability on the balance sheet under “dividends payable.”