How to Calculate Retained Earnings on a Balance Sheet
Gain clarity on a company's reinvested profits. Learn the precise calculation and balance sheet placement of this key equity figure.
Understanding a company’s financial health requires reviewing its financial statements. These formal records provide a comprehensive overview of a business’s activities and position. They help stakeholders, such as investors and creditors, assess profitability and overall economic stability.
Defining Retained Earnings
Retained earnings represent the cumulative profits a business has generated since its inception that have not been distributed to shareholders as dividends. These earnings are kept within the company and reinvested, indicating its financial strength and ability to fund future operations.
The purpose of retained earnings is to provide internal capital for business growth and stability. Companies often use these funds to invest in new equipment, expand operations, fund research and development, or pay down debt. A healthy balance of retained earnings can also build financial reserves, offering a safety net for unforeseen challenges or economic downturns.
Elements of the Retained Earnings Calculation
Calculating retained earnings involves combining several financial components. The first component is the beginning retained earnings balance. This figure represents the accumulated retained earnings from all prior accounting periods, serving as the starting point for the current period’s calculation. This balance is typically carried over from the previous fiscal period.
Net income, or net loss, is another element derived from the company’s income statement. Net income represents the profit a company makes over a specific accounting period after all expenses have been deducted from revenue. A positive net income increases retained earnings, while a net loss decreases them, reflecting the company’s profitability during the period.
Finally, dividends paid to shareholders are factored into the calculation. Dividends are the portion of a company’s profits distributed to its owners. These distributions reduce the amount of earnings retained by the company.
Performing the Retained Earnings Calculation
The calculation of retained earnings follows a standard formula: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings. This formula systematically updates the accumulated profits of a business. It accounts for the financial activity over a specific period, typically a quarter or a year.
To illustrate, consider a company that started its fiscal year with $100,000 in retained earnings. During the year, the company generated a net income of $50,000. Additionally, it paid out $10,000 in dividends to its shareholders.
Applying the formula, you would add the net income to the beginning retained earnings: $100,000 (Beginning Retained Earnings) + $50,000 (Net Income) = $150,000. From this sum, you subtract the dividends paid: $150,000 – $10,000 (Dividends) = $140,000. Therefore, the company’s ending retained earnings for the period would be $140,000.
Retained Earnings on the Balance Sheet
The calculated retained earnings figure is presented on a company’s balance sheet, specifically within the shareholders’ equity section. The balance sheet provides a snapshot of a company’s financial position at a specific point in time, detailing its assets, liabilities, and equity.
Retained earnings contribute to the overall balance sheet equation: Assets = Liabilities + Equity. A higher retained earnings balance indicates that a company has successfully accumulated and reinvested profits, which can strengthen its equity position. This figure reflects the portion of accumulated profits that have been plowed back into the business rather than being distributed, signaling the company’s capacity for self-funding and growth.