Where to Find Retained Earnings on Financial Statements

Retained earnings represent the accumulated net income of a company that has not been distributed to shareholders as dividends. This financial figure is a measure of a business’s capacity to generate profits and reinvest them back into its operations. By retaining earnings, a company can fund future growth initiatives, pay down debt, or build a financial cushion for unexpected challenges. These earnings serve as an internal source of capital, supporting long-term stability and expansion without needing to seek external financing.

Locating Retained Earnings on Financial Statements

Retained earnings primarily appear on two core financial documents: the Statement of Changes in Equity and the Balance Sheet. The Statement of Changes in Equity, sometimes referred to as the Statement of Retained Earnings, provides a detailed reconciliation of the retained earnings balance over a specific accounting period. This statement begins with the retained earnings balance from the start of the period, adjusts for net income or loss and dividends declared, and concludes with the ending balance for the period.

The Balance Sheet presents retained earnings as a cumulative figure within the equity section. This statement provides a snapshot of a company’s financial position at a single point in time. On the balance sheet, retained earnings are typically listed below other equity accounts such as common stock and additional paid-in capital. The amount displayed represents the total accumulated earnings that have been reinvested in the business since its inception, less any dividends paid out over that entire history. Therefore, while the Statement of Changes in Equity shows the activity over a period, the Balance Sheet presents the ultimate result of that activity up to the reporting date.

Understanding the Calculation of Retained Earnings

The basic calculation begins with the retained earnings balance from the close of the previous accounting period. To this beginning balance, the net income (or net loss) from the current period is added or subtracted. Any dividends declared and paid to shareholders during the period are then subtracted. This yields the ending retained earnings balance for the current period.

The net income or loss component is derived directly from the company’s income statement, representing its profitability after all expenses, including federal corporate income taxes. For C corporations, for example, the Tax Cuts and Jobs Act of 2017 established a flat federal corporate tax rate of 21% on taxable income, which impacts the net income figure. Dividends are distributions of a company’s profits to its shareholders, typically approved by the board of directors. These distributions, most commonly cash dividends, reduce the amount of earnings available for reinvestment in the business.

For example, if a company started the year with $100,000 in retained earnings, generated a net income of $50,000, and declared cash dividends totaling $20,000, the calculation would be $100,000 + $50,000 – $20,000, resulting in an ending balance of $130,000. This ending balance then becomes the beginning retained earnings for the next accounting period, allowing for a continuous tracking of accumulated profits.

Interpreting Retained Earnings

Interpreting the retained earnings balance offers valuable insights into a company’s financial health and strategic decisions. A consistently positive and growing retained earnings balance generally indicates that a company has been profitable over time and is reinvesting those profits back into the business. This accumulated capital can be used to fund various internal initiatives, such as capital expenditures for new equipment, investments in research and development, or the repayment of outstanding debt obligations. Such a trend often signals a company’s ability to finance its growth internally, reducing its reliance on external borrowing or issuing new equity.

Conversely, a declining or negative retained earnings balance, often referred to as an accumulated deficit, can suggest consistent losses over multiple periods or aggressive dividend payouts that exceed current earnings. A negative balance means the company has collectively lost more money than it has earned since its inception. This situation might indicate financial distress or a strategic choice to return capital to shareholders, potentially limiting future internal investment capacity. Companies with declining retained earnings may need to seek external financing, such as issuing new shares or taking on additional loans, to fund operations or expansion.

It is important to remember that retained earnings are an accounting concept and do not represent a specific cash balance. Instead, they reflect the portion of a company’s equity that has been generated from its profitable operations and subsequently reinvested into its assets. The actual cash may be held in various forms, including bank accounts, inventory, or property, plant, and equipment. Understanding this distinction helps in recognizing that while high retained earnings suggest financial strength, the company’s liquidity also depends on its current cash position and overall asset structure.