How to Find Retained Earnings Using the Income Statement

Retained earnings represent the cumulative profits a company has accumulated over time, which have not been distributed to its shareholders as dividends. Instead, these earnings are “retained” by the business to be reinvested, used to pay down debt, or for other strategic purposes. While many people might initially look for retained earnings directly on the income statement, this is a common misconception. The income statement provides a company’s financial performance over a period, culminating in its net income or loss, which is a foundational element for calculating retained earnings. Understanding retained earnings requires looking at how various financial statements connect, illustrating a company’s financial health and its strategy for growth.

The Income Statement’s Role

The income statement, often referred to as the profit and loss (P&L) statement, serves as a report card for a company’s financial performance across a specific accounting period, such as a fiscal quarter or a full year. This statement details the revenues earned and the expenses incurred to generate those revenues. Its primary components include sales revenue, the cost of goods sold, operating expenses like salaries and rent, and any non-operating gains or losses.

The systematic presentation of these items on the income statement ultimately leads to the calculation of net income, or net loss, which is considered the “bottom line” of the statement. This net income figure signifies the profit a company has left after deducting all expenses, including taxes, from its total revenues. While retained earnings themselves do not appear on the income statement, the net income (or net loss) reported here is the only direct financial link from this statement to the calculation of retained earnings.

The Statement of Retained Earnings

The statement of retained earnings acts as a crucial link between the income statement and the balance sheet, specifically detailing how the retained earnings balance changes over an accounting period. This statement begins with the retained earnings balance from the end of the previous period. To this starting figure, the net income (or net loss) from the current period’s income statement is added.

Following the addition of net income, any dividends paid out to shareholders during the period are subtracted from this sum. The resulting figure is the ending retained earnings balance for the current period.

The Balance Sheet: Final Destination

The balance sheet provides a snapshot of a company’s financial position at a specific point in time, unlike the income statement which covers a period. It is structured around the fundamental accounting equation: Assets = Liabilities + Owner’s Equity. This statement categorizes what a company owns (assets), what it owes to others (liabilities), and the residual value belonging to its owners (owner’s or shareholders’ equity).

Within the owner’s equity section, retained earnings are reported. The “ending retained earnings” figure calculated on the statement of retained earnings is precisely the amount that appears on the balance sheet. This cumulative amount is a significant indicator of a company’s financial strength and its capacity for future growth through reinvestment.

Calculating Retained Earnings

The calculation of retained earnings follows a straightforward formula that integrates information from both the income statement and the previous period’s financial records. The explicit formula is: Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings.

The “Beginning Retained Earnings” refers to the retained earnings balance from the end of the prior accounting period, which serves as the starting point for the current calculation. “Net Income” is the profit or loss reported on the income statement for the current period, increasing the retained earnings if positive or decreasing them if negative. “Dividends” represent any amounts of profit distributed to shareholders during the period, which reduce the retained earnings. For instance, if a company began with $100,000 in retained earnings, earned $50,000 in net income, and paid $10,000 in dividends, its ending retained earnings would be $100,000 + $50,000 – $10,000 = $140,000.