How to calculate retained earnings - Formula, examples and video

Every growing business needs reliable financial metrics to make informed decisions. One of the most important metrics is retained earnings—a key indicator of your business's profitability and how much it reinvests. Understanding how to calculate retained earnings helps you assess long-term financial health and your ability to fund growth, reduce debt, or distribute dividends.

Here’s everything you need to know about retained earnings, including the formula, examples, and practical tips. Use the links below to jump to any section:

Jump to:

• What are retained earnings?
• What affects retained earnings?
• Retained earnings vs. dividends vs. net income
• How to calculate retained earnings
• What affects the retained earnings balance?
• How retained earnings appear on the balance sheet
• Income statement sample
• Classifying assets and liabilities
• Balance sheet sample
• Prep early for a stress-free tax season [Conclusion]

What are retained earnings?

Retained earnings are the portion of net income that a company keeps instead of paying out as dividends. They’re part of shareholders’ equity on the balance sheet and reflect the company’s accumulated profits over time.

For example, if your business earns $20,000 in profit after expenses and taxes and doesn’t pay dividends, that full amount becomes retained earnings. Companies reinvest retained earnings to buy equipment, expand product lines, or acquire other businesses.

What affects retained earnings?

The retained earnings balance changes over time based on profits, losses, and dividends. Common factors include:

• Net income: Profitable periods increase retained earnings.
• Net losses: Losses reduce the retained earnings balance.
• Cash dividends: Payments to shareholders decrease retained earnings.

Business lifecycle and industry norms also affect how much companies retain. Startups typically reinvest most profits, while mature companies might distribute more dividends.

Retained earnings vs. dividends vs. net income

Here’s how these terms compare:

• Retained earnings: Cumulative profits kept in the business.
• Net income: Profit from one period after subtracting all expenses.
• Dividends: Profits paid out to shareholders.

Net income flows into retained earnings after each accounting period. If dividends are paid, they’re subtracted from retained earnings.

How to calculate retained earnings

The retained earnings balance is the total amount of company earnings (net income) since the beginning, minus all cash dividends it has paid over time. To visualize these calculations, you can use two financial reporting documents: an income statement and a balance sheet.

Follow these steps to calculate retained earnings:

• Step 1: Start with the beginning retained earnings. Find this number on the balance sheet from the previous accounting period.
• Step 2: Add net income (or subtract net loss). Use the income statement to determine your company’s profit or loss for the period.
• Step 3: Subtract dividends paid. Deduct any cash dividends distributed to shareholders.
• Step 4: Get ending retained earnings. The result is your retained earnings for the current period. 

Example retained earnings calculation

Let’s say your business had:

• Beginning retained earnings: $50,000
• Net income: $20,000
• Dividends paid: $5,000

Ending Retained Earnings = $50,000 + $20,000 - $5,000 = $65,000

That $65,000 can now be reinvested or held for future use.

What affects the retained earnings balance?

As your business grows and changes, you’ll find that its retained earnings on a balance sheet can be smaller or larger than in a previous period. Here are some common transactions that can cause these changes:

• Increase in net income: When a company earns more revenue than the previous year and expenses stay the same, retained earnings could increase. 
• Decrease by a net loss: A growing business that pays higher operating expenses than the previous year could suffer a net loss of income and, ultimately, decreased retained earnings. 
• Payment of cash dividends: If a company sells more shares of its stock to shareholders, the increased expense of cash dividend payouts could decrease retained earnings.

Dividend payments can vary widely, depending on the company and the firm’s industry. On average, established businesses that generate consistent earnings make larger dividend payouts because they have larger retained earnings balances in place. However, a startup business may retain all of the company's earnings to fund growth.

Retained earnings allow businesses to fund expensive asset purchases, add a product line, or buy a competitor. Your firm’s strategy should influence how you choose to use retained earnings and cash dividend payments.

There are two more things to keep in mind with retained earnings:

• When a stock dividend is paid, the company rewards shareholders by issuing more shares rather than a cash payment.
• When a company declares a cash dividend, its total cash balance decreases by the amount of the dividend payment

How to calculate net income

Use your income statement to determine net income:

Net Income = Total Revenue - Total Expenses

Steps:

1. Total revenue: Includes sales and gains from asset sales.
2. Total expenses: Includes COGS, rent, salaries, and other operating costs.
3. Subtract expenses from revenue to get net income.

Gross profit vs. net income

Net income accounts for all operating and non-operating expenses, while gross profit only subtracts direct production costs.

Gross profit = Revenue - Cost of Goods Sold (COGS)

Example:

• Revenue: $120,000
• COGS: $18,000
• Gross Profit: $102,000

Net income would subtract other expenses like rent, payroll, and taxes.

How retained earnings appear on the balance sheet

Retained earnings show up under shareholders’ equity on the balance sheet. They’re calculated after accounting for all assets and liabilities:

Assets = Liabilities + Equity

Use this equation to ensure your financial records stay balanced.

Example: You issue a $10,000 bond:

• Debit cash (asset): +$10,000
• Credit bonds payable (liability): +$10,000
• Equity remains unchanged, and the balance sheet stays in sync

Is retained earnings a debit or credit?

Retained earnings typically carry a credit balance. If a business incurs consistent losses over time, the account may show a debit balance, but that’s rare.

Income statement sample

If you use it correctly, an income statement will reveal the total net income of your business by calculating the difference between your assets and liabilities. This document is essential as you learn how to calculate retained earnings and other equities.

Here’s an example of a completed income statement:

Classifying assets and liabilities

To build an accurate balance sheet, you’ll need to sort your accounts into short-term (current) and long-term (non-current) categories. This classification helps you assess liquidity, solvency, and overall financial health.

• Current assets: Cash and other assets that you expect to convert into cash in 12 months or less, including accounts receivable and inventory balances
• Current liabilities: Liabilities that you must pay in cash within a year, including accounts payable
• Working capital: Current assets minus current liabilities. To finance short-term obligations, successful businesses maintain a positive working capital balance.

As you work through this part, remember that fixed assets are considered non-current assets, and long-term debt is a non-current liability.

Understanding the equity section of a balance sheet

If a business sold all of its assets and used the cash to pay all liabilities, the leftover money would equal the equity balance. This is why equity is a company’s real value. When one company buys another, the purchaser buys the equity section of the balance sheet.

The shareholders’ equity section includes common stock, additional paid-in capital, and retained earnings.

• Issuing common stock: Par value is a dollar amount used to allocate dollars to the common stock category. Custom Furniture’s common stock balance is $20,000.
• Posting additional paid-in capital: Additional paid-in capital is the amount of money shareholders invest that exceeds the common stock balance. The additional paid-in capital balance is $15,000.

Balance sheet sample

Now that you’ve learned how to calculate retained earnings, accuracy is key. The purpose of a balance sheet is to ensure all your bookkeeping journal entries are correct and every penny is accounted for. 

Here’s a detailed example of a completed balance sheet:

Prep early for a stress-free tax season

A company’s equity reflects the value of the business, and the retained earnings balance is an important equity account. To make informed decisions, you need to understand how financial statements like the balance sheet and the income statement impact retained earnings.

You can retain earnings, pay a cash dividend to shareholders, or choose a hybrid solution that addresses both. The details are up to you, and you should use what you’ve learned here to make smart decisions regarding retained earnings and the future of your business. You can stay on top of your earnings, get accurate reports, and easily track transitions with accounting software like QuickBooks.