How to Calculate Retained Earnings on a Balance Sheet

Retained earnings represent the cumulative profits of a business that have not been distributed to its shareholders as dividends. Instead, these earnings are kept within the company, often for reinvestment or to strengthen its financial position. This figure is a component of owner’s equity on a company’s balance sheet, reflecting the portion of profits that the business has chosen to retain over its operational life. Understanding how to calculate retained earnings provides insight into a company’s financial health and its capacity for internal financing.

Key Elements for Calculation

Calculating retained earnings requires understanding three primary financial figures that influence its balance. Each of these elements plays a distinct role in determining the final amount a company retains from its profits.

The first element is beginning retained earnings, which refers to the retained earnings balance from the end of the prior accounting period. This figure essentially serves as the starting point for the current period’s calculation, carrying over the accumulated profits that the business had chosen to keep up to that point.

Net income, or net loss, is the second crucial component. Net income represents a company’s profit after all expenses, including taxes, have been deducted from its revenues for a specific accounting period. When a business generates a net income, this amount increases its retained earnings, as it adds to the pool of profits available for retention or distribution. Conversely, a net loss for the period would decrease retained earnings, signifying that the company’s expenses exceeded its revenues.

The third element is dividends, which are distributions of a company’s profits to its shareholders. Dividends can be paid in cash or as additional shares, and they represent the portion of earnings that the company chooses not to retain. When dividends are paid out, they directly reduce the amount of retained earnings, as these funds are leaving the business and being distributed to owners.

The Retained Earnings Formula

The calculation of retained earnings relies on a straightforward formula that integrates the elements previously discussed. This formula provides a clear method for determining the ending balance of retained earnings for a given accounting period. It systematically accounts for the starting balance, the profits or losses generated, and any distributions made to shareholders.

The standard formula for calculating ending retained earnings is: Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends. This equation illustrates how the accumulated profits from prior periods are adjusted by the current period’s financial performance and shareholder distributions.

The net income generated during the current period is added to the beginning balance, as these profits increase the total amount of earnings available to the company. If the company incurred a net loss instead of net income, this loss would be subtracted, thereby reducing the retained earnings. Following this, any dividends paid out to shareholders during the period are subtracted from the sum of beginning retained earnings and net income. These distributions reduce the amount of profit that the company keeps within the business.

Applying the Formula with an Example

To illustrate the calculation of retained earnings, consider a hypothetical company, “Innovate Solutions Inc.,” at the end of its fiscal year. For the fiscal year ending December 31, 2024, Innovate Solutions Inc. had a beginning retained earnings balance of $150,000.

During the 2024 fiscal year, Innovate Solutions Inc. reported a net income of $75,000. This profit was earned after accounting for all revenues and expenses, including federal income taxes. The company also distributed $20,000 in cash dividends to its shareholders throughout the year.

Using the retained earnings formula, the calculation is:
Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends
Ending Retained Earnings = $150,000 + $75,000 – $20,000
Ending Retained Earnings = $225,000 – $20,000
Ending Retained Earnings = $205,000

Therefore, the ending retained earnings balance for Innovate Solutions Inc. as of December 31, 2024, is $205,000. This final calculated figure would then be presented on the company’s balance sheet under the shareholder’s equity section. This placement on the balance sheet reflects that retained earnings are a component of the ownership claims on the company’s assets.