Whatever your reason for starting a business, there’s one thing that’s certain—you want to succeed. But Fundera reports that “about 20% of small businesses fail in their first year,” and 50% close up by year five. Boost your chances of success by learning how to find retained earnings—your business’s profits minus shareholder payments.
Retained earnings is great proof of your business’s financial performance, and careful bookkeeping helps you keep track of it. Say you’re looking to bring in investors or get a business loan. Use retained earnings to show that your company has good cash flow and can afford to pay lenders back.
To help you report on this metric, we’ve outlined the basics of retained earnings—including how to calculate and document it.
What is the retained earnings formula?
Find your retained earnings by deducting dividends paid to shareholders from the sum of your old retained earnings balance and net income (or loss) for the current period.
Beginning retained earnings + Net income (or loss) – Dividends paid= Retained earnings
Let’s break down each formula element.
- Beginning retained earnings balance refers to your retained earnings at the start of the accounting period you’re considering.
- Net income (or loss), also called net profit, is the income balance you have after deducting expenses from your total sales or revenue. Check your income statement for net income.
Income (or profit and loss) statement illustration
- Dividends paid refers to shareholder payments during the accounting period. If your company doesn’t have shareholders, use $0 for this part of the formula when calculating.
Retained earnings vs. revenue, net income, and shareholders’ equity
Revenue is the total income you make from sales before deducting operating expenses, taxes, and dividend payouts. Business revenue is calculated period by period and recorded at the top of your income statement.
Net income is your profit after deducting expenditures and is also measured by a specific period.
Shareholders’ equity (also called stockholder equity) is a combination of outstanding shares, common stock dividends, retained earnings, extra paid-in capital, and treasury stock. Generally, owner’s equity is your business’s assets minus liabilities at any given period of time.
Retained earnings is your net income less dividends. Retained earnings is worked out to date, meaning you add it up from a prior period to a current one.
How to calculate retained earnings
Calculate a retained earnings account as frequently as you create your company’s balance sheet. For better context, though, always look at retained earnings from the perspective of your business type.
If you run a seasonal business, like a snow removal company, your retained earnings will likely vary across quarters. But the retained earnings of a year-round business like a car shop will be more constant.
A cash dividend is the major factor that affects retained earnings calculation. When you make cash dividend payments to stakeholders, it reduces retained earnings. Depending on how much you pay out, you could even end up with negative retained earnings. A negative retained earnings balance implies that your company has incurred consistent losses—from the previous year or earlier.
At the same time, paying cash dividends decreases shareholders’ equity because it affects the company’s assets. And when assets go down for any reason, retained earnings dip, too.
Retained earnings calculation examples
Say you own a soap-making shop and want to bring in a few investors to expand the business. The investors want to know your to-date retained earnings. In the past year, you recorded these figures:
Beginning retained earnings: $160,000
Net income: $35,000
Dividends paid to shareholders: $20,000
Using these figures, here’s how you would calculate your retained earnings:
($160,000 + $35,000) – $20,000 = $175,000
By proving that your company is profitable enough—with $175,000 in retained earnings that can already be put toward expansion—the investor is likely to take a bet on you.
Or imagine you own a software development agency. You want to hire more developers since your client base is growing. In the last quarter, you recorded the following figures:
Beginning retained earnings: $210,000
Net income: $115,000
Dividends paid to shareholders: $70,000
Your retained earnings will be: ($210,000 + $115,000) – $70,000 = $255,000
Armed with this information, you can gauge whether your business will be able to afford more developer hires.
How to find retained earnings in financial statements
Retained earnings is usually a part of a company’s balance sheet or in a record of its own.
As you’ll see in the balance sheet example below, retained earnings is typically a line item in the shareholder’s equity section at the bottom right.
Balance sheet example
On the other hand, you can create a separate retained earnings statement with this template:
Use retained earnings to gauge your business’s financial health
There is no set retained earnings amount to aim for. But generally, financial professionals recommend keeping the figure close to or the same as your company’s total assets.
If your retained earnings becomes higher than your assets, it may be a sign that you aren’t making enough reinvestments to grow your business—which may discourage investors. And if your retained earnings is lower than your assets, it could mean that you’re spending too much or not making enough money.
Curious about other calculations you can use to measure your company’s financial health and working capital? Check out these 11 accounting formulas for small business owners!