Retained Earnings Formula: How to Get and Calculate It
Understand how a company's past profits are retained and used to build future financial capacity and growth.
Retained earnings represent a significant financial metric for businesses, offering insights into a company’s past profitability and future potential. This figure reflects the cumulative profits a company has chosen to keep and reinvest into its operations, rather than distributing them to shareholders as dividends. Understanding retained earnings is therefore important for assessing a company’s financial health and its capacity for sustained growth and development.
Understanding Retained Earnings
Retained earnings are the accumulated net income of a company that has not been paid out as dividends to its shareholders. This vital portion of a company’s profits is retained within the business to fund various corporate activities. These funds can be used for expansion, to repay debt, to acquire new assets, or to bolster working capital for day-to-day operations. The amount of retained earnings provides a clear indication of how much profit a company has historically reinvested back into itself. This accumulation of past profits appears on a company’s balance sheet, specifically within the equity section, representing a component of owner’s equity financed by reinvested profits rather than direct shareholder contributions.
The Retained Earnings Formula
Calculating retained earnings involves a straightforward formula that accounts for a company’s profitability and its dividend distributions over a period. The standard formula begins with the retained earnings from the previous period, adjusts for current profits or losses, and then subtracts any dividends paid. The resulting figure reveals the retained earnings at the end of the current accounting period. The formula is expressed as: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings. Each element of this formula is derived directly from a company’s regularly prepared financial statements, which are often prepared under Generally Accepted Accounting Principles (GAAP) and provide the necessary data for this calculation.
Identifying Formula Components
To calculate retained earnings, specific figures must be identified from a company’s financial records. The starting point is the beginning retained earnings, representing the accumulated balance from the prior accounting period, found on the previous period’s balance sheet, usually within the equity section. The next component is net income or net loss for the current period, reflecting profitability after all expenses, including taxes and interest, have been deducted from revenues. This number is prominently displayed on the company’s income statement. Finally, dividends represent the portion of profits distributed to shareholders, reducing retained earnings; this information can be found in the financing activities section of the statement of cash flows or on the statement of retained earnings.
Calculating Retained Earnings
The process of calculating retained earnings involves systematically applying the formula using identified financial figures. First, locate the beginning retained earnings balance, which is the retained earnings reported at the end of the immediately preceding accounting period, serving as the baseline for the current period’s calculation. Next, identify the net income or net loss for the current reporting period from the company’s income statement. If the company generated a profit, this amount will be added to the beginning retained earnings; conversely, if the company incurred a net loss, this amount will be subtracted from the beginning balance, reflecting a decrease in accumulated earnings. Finally, account for any dividends paid to shareholders during the period, subtracting these payments from the sum of beginning retained earnings and net income (or net loss) to arrive at the ending balance.