How to Calculate Retained Earnings From a Balance Sheet

What Are Retained Earnings?

Retained earnings represent the cumulative net income a company has accumulated since its inception, less any dividends paid out to shareholders. These are the profits a business has chosen to keep within its operations rather than distributing them to investors. For instance, if a company earns a profit but does not pay out any dividends, that entire profit contributes to its retained earnings.

This accumulation of profits is distinct from a company’s current period net income, which represents the profit generated over a single accounting period. Retained earnings build up over many periods, providing a comprehensive picture of a company’s long-term profitability and capacity for self-financing. A healthy retained earnings balance often signals a company’s financial stability and its potential to expand operations, develop new products, or pay down debt without needing external financing.

Overview of the Balance Sheet

The balance sheet serves as a financial snapshot of a company’s financial position at a specific moment in time. It provides a summary of what a company owns, what it owes, and the equity held by its owners. This statement is structured around the fundamental accounting equation: Assets equal Liabilities plus Equity. This equation ensures that a company’s resources are always balanced by the claims against those resources.

Within the equity section of the balance sheet, retained earnings are prominently reported. While the balance sheet presents the final retained earnings figure, understanding its origin requires examining how various financial activities contribute to this amount.

Identifying Necessary Components

Calculating the current period’s ending retained earnings balance requires specific financial figures. The starting point is the beginning retained earnings balance, representing accumulated profits from all prior accounting periods. This figure is typically found on the prior period’s balance sheet or the current period’s statement of retained earnings.

Another component is the company’s net income or net loss for the current accounting period, found on the income statement. This figure summarizes a company’s revenues and expenses. A positive net income increases retained earnings, while a net loss reduces them.

Finally, any dividends declared or paid to shareholders during the period must be identified. Dividends represent a distribution of a company’s profits to its owners, reducing the earnings retained within the business. Information on distributions can be found in the statement of cash flows or footnotes to the financial statements. These three components are necessary for accurately determining the updated retained earnings figure.

Performing the Calculation

Once the necessary financial figures have been identified, the calculation of the ending retained earnings balance for the current period can be performed using a straightforward formula: Ending Retained Earnings = Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends. This equation systematically adjusts the prior period’s accumulated profits for the current period’s performance and distributions.

To illustrate, consider a hypothetical company that began the current year with a retained earnings balance of $100,000. During the year, the company generated a net income of $50,000 and paid out $10,000 in dividends to its shareholders. Applying the formula, the calculation would be $100,000 + $50,000 – $10,000, resulting in an ending retained earnings balance of $140,000.

This calculated ending balance is the figure reported on the company’s balance sheet for the current period. This approach ensures the balance sheet accurately reflects the updated portion of equity derived from a company’s ongoing profitability and distribution policies.

Understanding the Result

The calculated retained earnings figure offers significant insight into a company’s financial story. A positive and growing retained earnings balance indicates that a company has consistently generated profits and reinvested a portion back into the business. This often suggests financial strength, a capacity for organic growth, and the ability to fund future initiatives. Such a balance also represents the potential for future dividend payouts.

Conversely, a negative retained earnings balance, known as an accumulated deficit, signifies that a company has incurred more losses than profits over its operational history, or has distributed more in dividends than it has earned. This can be common for new companies in their early stages or for mature companies facing challenges. While the current retained earnings figure is informative, its true meaning becomes clearer when analyzed alongside a company’s historical performance and its complete financial statements.