How to Calculate Retained Earnings on the Balance Sheet
Learn how to accurately calculate and report a company's accumulated profits on its financial statements, a key indicator of financial strength.
Retained earnings are the cumulative profits a company has kept over its operating history, rather than distributing them to shareholders. These accumulated earnings represent a portion of a company’s financial health, indicating its capacity for reinvestment and growth. This article will guide you through the process of calculating retained earnings for inclusion on a company’s balance sheet.
Identifying the Necessary Financial Data
Before calculating retained earnings, financial information must be gathered. This data typically comes from a company’s financial statements and internal records. The three primary components needed for the calculation are beginning retained earnings, net income or net loss, and dividends declared.
Beginning retained earnings is the balance from the end of the previous accounting period. This figure serves as the starting point for the current period’s calculation. You can find this amount on the prior period’s balance sheet, within the equity section.
Net income or net loss represents the company’s profitability or deficit for the current accounting period. Net income is the revenue remaining after all expenses, interest, and taxes have been subtracted. Conversely, a net loss occurs when expenses exceed revenues. This figure is obtained directly from the company’s income statement.
Dividends declared are the distributions of profits a company decides to pay out to its shareholders. While dividends are not considered an expense and do not appear on the income statement, they reduce the amount of earnings a company retains. Information regarding dividends declared is found in the company’s general ledger or shareholder records, and they are reflected in the statement of stockholders’ equity.
Applying the Retained Earnings Formula
The calculation of retained earnings follows a standard accounting formula. This formula connects a company’s profitability and its distribution policies to the accumulated earnings it keeps. The formula for calculating ending retained earnings is: Ending Retained Earnings = Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends.
Beginning retained earnings serves as the foundation, representing the cumulative earnings from all prior periods that the company has kept. Net income is added to this starting balance because it signifies the profits generated during the current period that increase the company’s total accumulated earnings. Conversely, if a company incurs a net loss, this amount is subtracted, as it reduces the cumulative earnings.
Dividends are subtracted from the sum of beginning retained earnings and net income. This subtraction occurs because dividends represent a portion of earnings distributed to shareholders, meaning they are no longer retained by the company. This formula ensures the ending retained earnings balance accurately reflects the portion of profits a company has chosen to retain within the business.
Step-by-Step Calculation Example
To illustrate the calculation of retained earnings, consider a hypothetical company, “Example Corp.” At the beginning of the fiscal year, Example Corp. had a retained earnings balance of $150,000. This balance represents prior accumulated profits.
During the current fiscal year, Example Corp. generated a net income of $75,000. This profit adds to cumulative earnings. The company also declared and paid out $20,000 in dividends to its shareholders during the year.
Applying the retained earnings formula, the calculation would proceed as follows:
- Starting with the beginning retained earnings of $150,000.
- Adding the current period’s net income of $75,000: $150,000 + $75,000 = $225,000.
- Subtracting the dividends paid of $20,000: $225,000 – $20,000 = $205,000.
- Therefore, Example Corp.’s ending retained earnings for the current fiscal year are $205,000.
This final figure represents the total accumulated earnings retained by the company.
Reporting Retained Earnings on the Balance Sheet
Once calculated, retained earnings are presented on the balance sheet, a financial statement that provides a snapshot of a company’s financial position at a specific point in time. Retained earnings are found within the shareholder’s equity section of the balance sheet. This placement is significant because retained earnings represent a part of the owners’ claim on the company’s assets.
As a component of owner’s or shareholder’s equity, retained earnings contribute to the overall equity balance. This aligns with the fundamental accounting equation: Assets = Liabilities + Equity. An increase in retained earnings directly increases the total shareholder’s equity, which in turn balances with the company’s assets and liabilities.
On a balance sheet, the equity section might appear as follows:
Shareholder’s Equity
- Common Stock: $X
- Additional Paid-in Capital: $Y
- Retained Earnings: $205,000
- Total Shareholder’s Equity: $Z
This presentation shows the accumulated earnings that have been reinvested in the business or held as a reserve, highlighting how a company’s past profitability contributes to its current financial structure. The figure directly impacts the overall health and perceived value of the company to investors and other stakeholders.