What Is the Formula to Calculate Retained Earnings?

Retained earnings are a portion of the profits a business keeps rather than distributing to its shareholders. They are a significant part of shareholder equity, reflecting accumulated earnings that have been reinvested in the business over time. This internal funding source supports a company’s growth, stability, and future endeavors. Understanding retained earnings provides insight into how a company manages its profits and plans for its long-term financial health.

Understanding Retained Earnings

Retained earnings represent the cumulative net income of a company that has not been paid out as dividends. These profits are held by the business for purposes such as reinvestment in operations, funding expansion, or reducing debt obligations. This accumulation of profits signifies a company’s financial strength and its capacity for self-financing future growth without relying solely on external funding.

These accumulated profits are reported on the balance sheet within the shareholder equity section, linking the company’s profitability from the income statement to its financial position. They reflect an ongoing accumulation over multiple accounting periods, not just a single period’s profit or loss. A positive retained earnings balance indicates that a company has historically generated more profits than it has distributed, while a negative balance, sometimes called an accumulated deficit, means cumulative losses have exceeded cumulative profits.

The Retained Earnings Formula

The calculation of retained earnings accounts for a company’s profitability and its dividend distributions. This calculation updates the accumulated earnings from the previous period to reflect the current period’s financial performance. The formula explicitly shows how net income adds to, and dividends subtract from, the retained earnings balance.

The formula for calculating ending retained earnings is: Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends. This formula highlights that the retained earnings at the end of a period are determined by starting with the amount from the beginning of that period, adding any profits earned, and then subtracting any amounts paid out to shareholders. This calculation is performed at the end of each accounting period, whether monthly, quarterly, or annually.

Identifying the Formula Components

The “Beginning Retained Earnings” is the starting point for the calculation and represents the ending retained earnings balance from the immediately preceding accounting period. This figure can be found on the previous period’s balance sheet, typically within the equity section, or on a statement of retained earnings.

The “Net Income” (or net loss) component reflects the company’s profitability for the current accounting period. This figure is located at the bottom of the income statement, often referred to as the “bottom line.” Net income represents the total revenue minus all expenses, including taxes and interest, for that period.

“Dividends” refer to the portion of profits that a company has distributed to its shareholders during the period. These amounts are not expenses and do not appear on the income statement. Dividends paid are typically found in the financing activities section of the statement of cash flows or explicitly noted on the statement of shareholders’ equity or statement of retained earnings.

Practical Calculation Examples

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. If the company did not distribute any dividends to its shareholders, the calculation would be $150,000 (Beginning Retained Earnings) + $75,000 (Net Income) – $0 (Dividends) = $225,000. This results in an ending retained earnings balance of $225,000.

In another scenario, imagine a company began the quarter with $300,000 in retained earnings. Over that quarter, the business reported a net income of $60,000. However, the company also paid out $20,000 in dividends to its shareholders. The calculation would then be $300,000 (Beginning Retained Earnings) + $60,000 (Net Income) – $20,000 (Dividends) = $340,000. The ending retained earnings for this company at the end of the quarter would be $340,000.

Even if a company experiences a net loss, the formula remains consistent. For example, if a company had $50,000 in beginning retained earnings and incurred a net loss of $10,000 for the period, while paying no dividends, the calculation would be $50,000 + (-$10,000) – $0 = $40,000. The retained earnings would decrease to $40,000, reflecting the net loss. These examples demonstrate the direct application of the formula to determine the updated retained earnings balance for a given period.