Is Retained Earnings on the Balance Sheet or Income Statement?
Discover how a company's past accumulated profits are presented in its financial reports and how current performance impacts this crucial figure.
Financial statements provide a structured view of a company’s financial health. They offer stakeholders, like investors and creditors, data for informed decisions. Retained earnings are a key figure for understanding a company’s financial position and historical performance.
What Retained Earnings Represent
Retained earnings are the cumulative portion of a company’s net income not distributed to shareholders as dividends. This accumulated profit is essentially reinvested back into the business operations.
This accumulated profit serves as an internal source of funding for various corporate activities. Companies often use retained earnings to:
Finance expansion projects.
Acquire new assets.
Pay down existing debt obligations.
Fund research and development initiatives.
By retaining earnings, a company strengthens its financial position and supports future growth without needing to borrow money or issue new stock.
The Balance Sheet and Retained Earnings
The balance sheet provides a snapshot of a company’s financial position at a specific point in time, detailing its assets, liabilities, and equity. This statement adheres to the fundamental accounting equation: Assets = Liabilities + Equity. Retained earnings are a component of the equity section on the balance sheet.
Within the equity section, retained earnings represent the portion of owners’ claims on the company’s assets originating from accumulated profits. Other equity accounts, such as common stock and additional paid-in capital, represent funds contributed directly by shareholders. Retained earnings, by contrast, signify the profits generated and held by the business itself, contributing to the overall ownership stake.
The Income Statement’s Connection
The income statement, also known as the profit and loss (P&L) statement, summarizes a company’s revenues, expenses, gains, and losses over a specific accounting period, such as a quarter or a year. The ultimate result of the income statement is the net income or net loss, which indicates the company’s profitability during that period. Retained earnings are not directly listed on the income statement itself.
The income statement’s net income (or loss) is the link to the retained earnings balance. Profit generated during a period, as reported on the income statement, directly impacts the retained earnings balance on the balance sheet. This net income figure updates the retained earnings account, increasing it with a profit or decreasing it with a loss. The income statement explains performance over a period, while retained earnings reflect the cumulative impact of past performances.
How Retained Earnings are Calculated
The calculation of retained earnings involves a straightforward formula connecting the beginning balance with the current period’s performance and any distributions. The formula is: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings.
For example, if a company started the year with $500,000 in retained earnings, earned a net income of $150,000, and paid out $50,000 in dividends, the ending balance would be $600,000 ($500,000 + $150,000 – $50,000). Dividends represent a decision by the company’s board of directors to distribute profits to owners. This calculation demonstrates how operating results and distribution policies jointly determine the retained earnings reported on the balance sheet.