Retained earnings refer to the earnings retained by the company rather than sharing it with the shareholders in the form of dividends.
So, basically, the businesses or industries that yield good profits that can be shared amongst their stockholders are eligible for retained earnings.
With this blog, we focus on business owners like you to clarify retained earnings with examples + calculation formulas.
So, let’s begin the blog and learn how to calculate retained earnings most easily.
What is Retained Earnings?
The basic definition of retained earnings refers to the portion of the profits that a company has kept aside for the reinvestment or dividends of the shareholders but are utilized by the company itself and are retained by the company for paying off debts or for recovering from any uncertain loss.
Let’s put it into a simple example to understand it better.
- An XYZ company has earned $$$ profits for the financial year 2024-2025. The XYZ company can choose to share some portion of the profits with their investors or shareholders in the form of dividends.
- Also, the XYZ company can, however, choose not to share the profits and keep the profits with the company in a retained form to face any unknown losses or foreseen expenses or major investments.
Wondering how to get retained earnings, it’s simple.
Companies can get retained earnings by not sharing the earned profits in the form of dividends or any new investments.
How to Find Retained Earnings in Your Business Statements?
Well, often, business owners are confused about where exactly the retained earnings are shown or found.
So, don’t be confused about how to find retained earnings, as we are here to help you out.
Retained earnings can be found exactly in two different business statements.
| Income Statement or P&L | Balance Sheet |
|---|---|
| Retained earnings are found at the bottom of the income statement or P&L statement. | Retained earnings are found in the shareholder’s equity section in the balance sheet. |
How To Calculate Retained Earnings?
Businesses can calculate retained earnings in a very easy and simple way.
There is no rocket science here.
So, how exactly is the retained earnings calculation done? Let’s check the three-piece calculation now.
- Check the Opening Retained Earnings Balance
- Add Your Net Profit to the Retained Earnings Balance (Deduct if it is a loss)
- Minus the Dividends that Need to be Paid to the Shareholders
Let’s elaborate on the three-piece information to know what is retained earnings for the current year.
1. Check the Opening Retained Earnings Balance
Check the last year’s balance sheet and scroll down to the equity section to get an idea of what has retained earnings for the last year, which is technically your this year’s opening balance.
2. Add Your Net Profit to the Retained Earnings Balance (Deduct if it is a loss)
After you have noted down the retained earnings for the last year, it is time to add the net profits to the retained earnings to find the total amount of balance that you have as a profit for the current year.
3. Minus the Dividends that Need to be Paid to the Shareholders
Now, you will have a total net profit + opening balance of the retained earnings, out of which you have to deduct the dividends that you need to pay to your investors or stockholders to get the retained earnings for the current year.
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How Do You Calculate Retained Earnings on the Balance Sheet?
While you want to calculate retained earnings on the balance sheet, follow these steps:
- Open the balance sheet for the financial year you are referring to.
- Check the equities section.
- Under the equities, the retained earnings are listed.
To calculate the retained earnings, you have to add the net profit to the current retained earnings and subtract the dividends, losses, or payouts.
Retained Earnings Formula
Retained Earnings = Beginning Period Retained Earnings + Net Income/Loss – Cash Dividends – Stock Dividends.
Example of Retained Earnings Calculation
Let’s have a look at the retained earnings formula, for example, to get a better idea of how to calculate retained earnings easily.
Albus is interested in expanding his current business. He is in contact with a few investors who can help him expand his business in the international market, but for the same, they demand to share their retained earnings to date.
Albus is now on his accounting books on how to find retained earnings for the current year.
His financial books of account look like this.
- Retained Earnings 150,000 USD
- Net Income 25,000 USD
- Dividends Paid 15,000 USD
So, now let us calculate the retained earnings formula here.
Retained Earnings = Beginning Period Retained Earnings + Net Income/Loss – Cash Dividends – Stock Dividends.
Retained Earnings of Albus’s Business= (125,000+25,000 USD) – (15,000 USD) = 135,000 USD
It indicates that Albus has 135,000 USD as retained earnings to show in his books of accounts. He can also lead the investors to move ahead with his business expansion using a good amount of retained earnings.
What’s the Difference Between Retained Earnings and Revenue?
Retained earnings calculation goes like this: Opening balance of the last year’s retained earnings + net profit – (dividends+loss+investments).
Revenue is the gross income, which doesn’t consider deductions such as expenses, costs, or dividends.
Hence, we can draw one conclusion: revenue is the income generated after selling the goods or services. It is, therefore, different from retained earnings as per the books of account.
What’s the Difference Between Retained Earnings and Dividends?
Let’s talk about Retained earnings.
Retained earnings = Opening balance of the last year’s retained earnings + net profit – (dividends+loss+investments).
Dividends refer to the payment the business owner shares with his stockholders or shareholders in cash or stocks. It is distributed from the total profit earned by the company for the particular year.
How Much Should My Retained Earnings Be?
Impressed that you are reading this section.
Now, let’s talk about how much retained earnings your business requires each year (approximate ratio).
Businesses generally prefer a 1:1 assets and retained earnings ratio, unrealistic or hyped, but aggressive entrepreneurs try to maintain this ratio.
However, the retained earnings on any business must be decided by considering the following five factors:
- Business’s Financial Goals and Needs
- Industry Standards
- Risk Tolerance
- Investor’s Expectations
- Dividend Policy
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What are the Advantages and Disadvantages of Retained Earnings Calculations?
| Advantages of Retained Earnings | Disadvantages of Retained Earnings |
|---|---|
| Financial Flexibility | Opportunity Cost for Shareholders |
| Growth Opportunities | Reduced Liquidity for Shareholders |
| Shareholder and Investor’s Confidence | Result in Risk for Poor Capital Allocation |
| Buffer Against Uncertainties | Increased Market Expectations |
| Tax Efficiency | Enhanced Investor Expectations |
Retained Earnings Calculation Made Easy
Businesses can follow the simple and quick retained earnings formula to calculate the retained earnings. It is best for your business to have retained earnings in order to have a buffer for any foreseen expenses.
FAQs
Jayanti Katariya is the founder & CEO of Moon Invoice, with over a decade of experience in developing SaaS products and the fintech industry. He holds a degree in engineering. Since 2011, Jayanti's expertise has helped thousands of businesses, from small startups to large enterprises, streamline invoicing, estimation, and accounting operations. His vision is to deliver top-tier financial solutions globally, ensuring efficient financial management for all business owners.
