If you run a business or plan to, understanding your finances is a must. And one term that pops up a lot—but often feels a bit confusing—is retained earnings. Sounds fancy, right? But don’t worry, we’re breaking it down in the simplest way possible. Think of this as your go-to guide on what retained earnings mean, how to calculate them, and why they matter.
Table of Contents
So, What Exactly Are Retained Earnings?
Let’s say your business makes a profit. You might pay yourself or your shareholders some of that profit as dividends. But what about the rest? That leftover portion—the profit you keep in the business, is called retained earnings.
In simple words:
Retained earnings = the money your business keeps instead of giving away.
That money is usually used to grow the business, pay off loans, or save for a rainy day. It’s a sign that your company is planning for the future.
Some entrepreneurs use retained earnings to explore new product lines or enter different markets. It can also be a financial cushion during downturns. Think of it as your business’s piggy bank, built not with spare change, but with smart financial decisions over time.
Are you currently managing your bookkeeping in-house?
Why Should You Care?
Because retained earnings are like a report card for your business’s long-term health. They show how much you’ve been able to save and reinvest over time. Banks love seeing strong retained earnings when you apply for a loan, and investors? Even more.
Did You Know? Some companies like Apple and Amazon have billions in retained earnings because they choose to reinvest in growth instead of paying out large dividends.
Retained earnings can also help build your business’s creditworthiness. A consistent track record of saving and reinvesting profits can paint your business as stable, trustworthy, and ready for bigger opportunities.
How To Calculate Retained Earnings?
Alright, let’s break down the formula on how to calculate retained earnings. It’s really just basic math to help you answer “How do you calculate retained earnings on a balance sheet”.
Retained Earnings = Beginning Retained Earnings + Net Income – Dividends Paid
Here’s what each part means:
- Beginning Retained Earnings: This is how much you had saved from previous years.
- Net Income: The profit your business made this year.
- Dividends Paid: The portion of profit you shared with shareholders.
Real-Life Example:
Let’s say:
You started the year with $40,000 in retained earnings.
You made $15,000 in profit this year.
You paid $5,000 to shareholders.
Then:
Retained Earnings = $40,000 + $15,000 – $5,000 = $50,000
That means you now have $50,000 saved up in the business.
Where Can You Find Retained Earnings?
Answer to how to find retained earnings is not very hard. You’ll spot retained earnings in the shareholders’ equity section of your balance sheet. If you use accounting software, this number is usually updated automatically.
Quick Tip: Don’t confuse retained earnings with cash on hand. Just because you have $50,000 in retained earnings doesn’t mean you have $50,000 in your bank account. It’s more like a summary of how much you’ve kept over time.
You might even find that as retained earnings increase, so does investor interest. Many savvy investors scan this number to get a sense of a company’s stability and profit strategy over the years.
What is the Statement of Retained Earnings?
Great question! It’s a small but mighty report that shows:
- The retained earnings at the beginning of a period
- Net income or loss during the period
- Dividends paid out
- The ending balance
It’s often included with your financial statements, especially when you’re applying for funding or presenting to investors.
Tip for You: Creating a statement of retained earnings quarterly can help you stay on top of your financial game.
Even if you’re a small business, having a clear retained earnings statement can give you an edge. It communicates transparency and demonstrates that you’re treating your business finances with the professionalism they deserve.
How Retained Earnings Help Your Business?
Here’s why this number matters:
- It shows discipline – You’re saving for the future.
- It signals growth – Reinvesting profits often leads to expansion.
- It improves borrowing chances – Lenders love seeing healthy retained earnings.
It’s attractive to investors – A business that reinvests wisely is one that builds long-term value.
Retention Ratio: Another Important Piece
This is another easy metric to know: it tells you what percentage of your profit you kept instead of paying out.
Retention Ratio = (Net Income – Dividends) / Net Income
Example:
You made $25,000 in profit.
Paid $5,000 in dividends.
Then:
(25,000 – 5,000) / 25,000 = 0.8 or 80%
You kept 80% of your profit in the business.
This ratio is especially helpful if you’re comparing your business year over year or measuring performance against competitors in your industry.
Is Retained Earnings an Asset or an Expense?
Neither. It’s not something you own like a laptop (asset) or something you pay like rent (expense).
It lives under shareholders’ equity on your balance sheet.
- Positive retained earnings = your business has made money over time.
- Negative retained earnings = your business has been losing money. This is sometimes called an “accumulated deficit.”
Three Key Components of Retained Earnings
To sum it up, there are only 3 ingredients:
- What you had before (Beginning Retained Earnings)
- What you earned (Net Income)
- What you gave away (Dividends Paid)
Stir them together, and you get your new retained earnings balance.
Conclusion
Retained earnings might sound like an accounting buzzword, but really, it’s a powerful measure of how well your business is doing and how smartly you’re planning for tomorrow.
It’s not just about what you earn—it’s what you keep. By keeping track of retained earnings and using them wisely, you’re not just running a business; you’re building a future.
Whether you’re a solopreneur or managing a growing team, understanding retained earnings gives you the power to make better decisions. It helps you stay focused on your financial goals while building a solid foundation for what’s next.
Frequently Asked Questions:
What is retained earnings in simple terms?
Retained earnings are the portion of your business’s profit that you keep instead of paying out as dividends. It’s like a savings fund used to grow the business, pay off debts, or handle unexpected expenses.
How do you calculate retained earnings on the balance sheet?
Use this formula: Beginning Retained Earnings + Net Income – Dividends Paid. It reflects how much profit has been retained over time and appears under shareholders’ equity on the balance sheet.
Is retained earnings an asset or expense?
It’s neither—it’s part of shareholders’ equity. Retained earnings represent accumulated profits, not something you own like an asset or spend like an expense.
What is the formula for calculating retention?
Retention Ratio = (Net Income – Dividends) / Net Income. This shows the percentage of profit your business retained instead of distributing it to shareholders.
What are the 3 components of retained earnings?
The main components are Beginning Retained Earnings, Net Income or Loss, and Dividends Paid. These determine how much profit your business has retained over time.
