What Does Retained Earnings Equal? (Formula & Definition)
Gain clarity on retained earnings: what they represent, how they're determined, and their vital role in a company's financial future.
Retained earnings represent a company’s accumulated profits that have been kept within the business rather than distributed to shareholders. This financial metric provides insight into a company’s financial health, reflecting its capacity for future growth and investment through reinvested profits.
What Retained Earnings Represent
Retained earnings are profits a company holds rather than distributing to shareholders as dividends. These funds are kept for internal purposes, such as expanding operations, funding research and development, or reducing debt.
These earnings accumulate over multiple accounting periods, representing the total profits saved since inception. This allows a company to finance ongoing operations and strategic initiatives without relying on external sources like new debt or equity issuance. Retaining earnings often indicates a company’s focus on long-term growth and stability.
How Retained Earnings are Calculated
Retained earnings are calculated using a formula that tracks changes over an accounting period: Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings. This calculation is performed at the end of each accounting period, such as monthly, quarterly, or annually.
Beginning Retained Earnings is the balance carried forward from the previous accounting period. Net Income, or profit, is total revenue minus expenses for the current period; a positive net income increases retained earnings, while a net loss decreases it. Dividends are payments made to shareholders from company profits, which reduce retained earnings.
For example, consider a company that started the year with $100,000 in retained earnings. During the year, it generated a net income of $50,000. The company then decided to pay $10,000 in dividends to its shareholders. Using the formula, the calculation would be $100,000 (Beginning Retained Earnings) + $50,000 (Net Income) – $10,000 (Dividends) = $140,000 (Ending Retained Earnings). This $140,000 becomes the beginning retained earnings for the next accounting period.
Retained Earnings and the Balance Sheet
Retained earnings appear on a company’s balance sheet within the shareholders’ equity section. This highlights its role as a component of the owners’ stake. Shareholders’ equity represents the residual value of a company’s assets after liabilities are deducted, and retained earnings contribute directly to this value alongside other equity components like contributed capital.
Retained earnings on the balance sheet signify an internal source of financing a company can leverage. These accumulated profits fund initiatives like purchasing new equipment, expanding facilities, investing in research, or paying down existing debt. Utilizing retained earnings allows a company to finance growth and operational needs without incurring additional debt or issuing new shares, which can dilute existing ownership.