How to Figure Out Retained Earnings With the Formula

Retained earnings represent the accumulated profits a company has kept over time rather than distributing them to shareholders as dividends. This financial metric indicates the portion of a business’s net income that is reinvested into its operations. Understanding retained earnings is fundamental for assessing a company’s financial standing and its strategy for future growth. It provides insight into how a business manages its earnings to support ongoing activities and development.

Understanding Retained Earnings

Retained earnings play a significant role in a company’s financial strategy, reflecting its capacity for self-financing. These accumulated profits can be utilized for various purposes, such as funding new projects, acquiring property or equipment, or reducing existing debt obligations. This figure is an important indicator for business owners and potential investors, as it provides insight into a company’s financial health and its approach to reinvestment. A company that consistently retains earnings often signals a commitment to long-term growth and stability.

Gathering the Necessary Financial Data

To calculate a company’s retained earnings, specific financial figures must be identified from standard financial statements. The starting point is the beginning retained earnings balance, which is the amount of retained earnings from the end of the previous accounting period. This figure is located on the prior period’s balance sheet or on a separate statement of retained earnings.

Next, the net income or net loss for the current accounting period is required. Net income represents the profit a company has earned after all expenses, including taxes, have been deducted from its revenues. This information is found on the company’s income statement.

Finally, any dividends declared during the current period must be determined. Dividends are distributions of a company’s profits to its shareholders. Information regarding dividends declared can be found on the statement of retained earnings or the statement of cash flows.

Applying the Retained Earnings Formula

Once the necessary financial data has been gathered, the retained earnings for the current period can be calculated using a formula. The formula is: Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings. This calculation updates the accumulated earnings figure to reflect the current period’s financial activities.

For example, consider a business that started the year with $150,000 in retained earnings. During the year, the company generated a net income of $75,000 and distributed $20,000 in dividends to its shareholders. Applying the formula, the calculation would be $150,000 (Beginning Retained Earnings) + $75,000 (Net Income) – $20,000 (Dividends).

This results in $205,000 as the ending retained earnings balance for the current period. This final figure represents the total accumulated earnings that the company has opted to keep and reinvest in its operations as of the end of the reporting period. It provides a clear snapshot of the portion of profits that remains within the business for future use.