What Are Retained Earnings on a Balance Sheet? (With Steps)

Updated October 20, 2022

Retained earnings refer to the amount of net income that a company retains. These earnings can fund future growth projects of a company or dividends for its shareholders. Understanding retained earnings can help you assess a company's financial performance.

In this article, we define retained earnings on a balance sheet, discuss how they compare to other key performance indicators (KPIs) and explain how to calculate retained earnings.

What are retained earnings on a balance sheet?

Retained earnings on a balance sheet are the amount of net income remaining after a company pays out dividends to its shareholders. Businesses generate earnings that they reflect on their balance sheet as negative earnings, or losses, and positive earnings, or profits. When a business reports positive earnings, the owner can use the surplus by reinvesting in the company or paying shareholders in the form of dividends. Any profits that a company has earned but not paid to shareholders count as retained earnings, which the company includes on the retained earnings section of its balance sheet.

Retained earnings vs. other KPIs

Here are the differences between retained earnings and other key performance indicators of a company:

Retained earnings vs. dividends

When a company's shareholders receive dividends, this can happen in the form of either stock or cash payments. Both forms of payment can reduce retained earnings. Accountants typically record cash payments of dividends as net deductions, which lead to cash outflow. Retained earnings are a lower amount because the asset value of the company is smaller on the balance sheet.

With stock dividends, the company's stock payments convert part of the retained earnings to common stock. For instance, if the company pays one share as a dividend for every share investors hold, the price per share might reduce because the number of shares can increase. The increase in shares might not affect the company's balance sheet, but it reduces the valuation of each share. Capital accounts typically reflect this, consequently affecting the company's retained earnings.

Retained earnings vs. revenue

Retained earnings and revenue are vital key performance indicators in assessing the financial health of a company, but they tell different things about the company's financial health. Revenue is the first KPI that financial analysts may look for at the top portion of the income statement and can provide a solid indicator of how a business is performing. Revenue refers to the money a business earns during a set period, but before deducting expenses and costs.

What do retained earnings tell you?

If a company has positive retained earnings, it means the company is profitable. This is because the company's retained earnings show profits after the payment of dividends and overheads. If the company has negative retained earnings, it means the company has accumulated more debt than the earnings it's generated.

It's important to have an overall understanding of a company's situation before assessing retained earnings. For instance, if a company has been trading for many years, negative retained earnings could mean that the business isn't profitable, and a review is necessary. When looking at the retained earnings of a company, consider the following factors:

The company's dividend policy: If a company pays out a dividend policy regularly, it may have a lower amount of retained earnings. A conservative dividend policy can mean a higher amount of retained earnings, which is common for privately held businesses.
A company's profitability: The more profitable a company is, the higher its amount of retained earnings may be.
The company's age: Smaller companies may not have had much time to generate retained earnings, so they often have a smaller amount of retained earnings. Senior companies may have had more time, so they typically have a higher amount of retained earnings.
The company's seasonality: In seasonal industries, such as the hospitality industry, companies may hold back retained earnings during profitable periods to help them through slow times. Accounting periods often reflect this with high retained earnings and other periods of negative or lower retained earnings.

How net income impacts retained earnings

Changes to the company's net income directly affect its retained earnings. Some key factors that can impact net income include the cost of goods sold, sales revenue, operating expenses and depreciation, or a drop in the value of what the company is offering to customers. Stock-based compensation, impairments and write-downs are all examples of noncash items that can have an effect on the company's net income, which then causes a change to its retained earnings.

To understand a company's financial position, it's important to look at the entire balance sheet, including the gross and net income figures and the retained earnings. Investing in a company is a major decision that involves careful financial analysis and an overall assessment of how the company is performing from a financial standpoint.

How to calculate retained earnings

Here are the steps you can take to calculate retained earnings:

1. Determine the current or beginning retained earnings

Companies often calculate retained earnings to date, which means they accrue from one period to the next. To begin calculating a company's current retained earnings, determine what they were at the beginning of the time period you're calculating, which is typically the previous quarter or year. Consider checking the company's balance sheet for the prior period to find its beginning retained earnings.

2. Find the company's net income for the current period

Net income refers to the total amount of money a company has earned in a given period of time, minus interest, expenses and taxes. You can easily find the company's net income on its income statement. If you want to calculate the company's net income manually, start with its total revenue. From this figure, subtract the company's expenses and operating costs to calculate its earnings before tax. Then, deduct tax from this amount to find the net income.

3. Find dividends paid to shareholders

Consider finding dividends that the company paid to shareholders during the quarter or year. If the company currently pays shareholders dividends, you can subtract the total paid from its previous retained earnings balance. If the company doesn't pay dividends, you can use $0 in the retained earnings formula.

4. Enter the figures in the retained earnings formula

If you have all the numbers you need, enter those values into the retained earnings formula. To calculate retained earnings, add the company's net income to, or subtract net losses from, the previous term's retained earnings. Then, subtract any net dividends paid to the shareholders. The equation looks like this:

Retained earnings = Beginning retained earnings + Profits or losses for the period - Dividends paid

Retained earnings on balance sheet example

The following is an example of retained earnings calculation:

An electronics manufacturer reports retained earnings of $30 billion on Aug. 28, 2022, which is the end of the company's 2022 fiscal year. In the same period, it reported $60 billion in shareholder equity and $100 billion in net income. The company performs the following calculations:

Retained earnings = $30 billion + $100 billion - 60 billion

Retained earnings = $70 billion

Applying these numbers to the formula shows that the company has $70 billion in retained earnings.

This article is for informational purposes only and does not constitute financial advice. Consult with a licensed financial professional for any issues you may be experiencing.