How to Calculate Retained Earnings on the Balance Sheet

Retained earnings represent the accumulated profits a business has kept and reinvested rather than distributing to shareholders. They serve as a measure of a company’s ability to generate and retain wealth over time. This financial metric is a component of a company’s total equity, reflecting how much profit has been reinvested into operations to support growth and stability.

Understanding Retained Earnings

Retained earnings represent the cumulative net income of a company from its inception, after accounting for any dividends paid to its shareholders. Businesses often use these accumulated profits to fund future growth initiatives, such as expanding operations, investing in new equipment, or developing new products.

Retained earnings can also be used to pay down existing debt obligations, which improves a company’s financial leverage and reduces interest expenses. A strong level of retained earnings indicates a company’s capacity for reinvestment and financial strength, providing insight into its long-term sustainability. This links a company’s income statement and balance sheet, as it directly impacts the equity section.

Calculating Retained Earnings

Calculating retained earnings involves a formula that tracks the changes in a company’s accumulated profits over a specific period: Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings. This calculation determines the profit a company has kept.

The “Beginning Retained Earnings” is the balance from the end of the previous accounting period, which can be found on the prior period’s balance sheet. “Net Income” is the company’s profit or loss for the current period, obtained from the income statement, where it reflects revenues minus expenses. If there is a net loss, this amount is subtracted. “Dividends” are distributions paid to shareholders during the period.

For example, if a company starts a period with $150,000 in retained earnings, earns a net income of $75,000 during the period, and pays out $25,000 in dividends, the calculation is: $150,000 (Beginning RE) + $75,000 (Net Income) – $25,000 (Dividends) = $200,000 (Ending Retained Earnings). This ending balance then becomes the beginning balance for the subsequent accounting period. This calculation is performed at the end of each accounting period, whether monthly, quarterly, or annually.

Retained Earnings on the Balance Sheet

Retained earnings are presented on a company’s balance sheet within the shareholders’ equity section. The balance sheet provides a snapshot of a company’s financial position, and retained earnings reflect the cumulative undistributed earnings up to that date.

Within the equity section, retained earnings appear alongside other equity accounts, such as common stock and additional paid-in capital. The ending retained earnings is directly posted to the balance sheet for the current year.

For instance, a simplified equity section might appear as:
Shareholders’ Equity
Common Stock: $1,000,000
Additional Paid-in Capital: $500,000
Retained Earnings: $200,000
Total Shareholders’ Equity: $1,700,000

This presentation demonstrates how retained earnings contribute to the overall net worth of the business. While retained earnings are part of equity, they are not themselves an asset, but rather represent a portion of the total equity that can be used to acquire assets or reduce liabilities. Under Generally Accepted Accounting Principles (GAAP), retained earnings must be shown as a separate line item on the balance sheet.