What are retained earnings?
Your retained earnings are the profits that your business has earned minus any stock dividends or other distributions.
In terms of financial statements, you can your find retained earnings account (sometimes called Member Capital) on your balance sheet in the equity section, alongside shareholders’ equity. In rare cases, companies include retained earnings on their income statements.
Your bookkeeper or accountant may also be able to create monthly retained earnings statements for you. These statements report changes to your retained earnings over the course of an accounting cycle.
How retained earnings are calculated
The formula for calculating retained earnings is:
Beginning Retained Earnings + Profit/Loss – Dividends = Retained Earnings
Say you just started a business. Your beginning retained earnings would be $0. If your amount of profit is $50 in your first month, your retained earnings are now $50.
Beginning Retained Earnings = $0
Profit/Loss = $50
Dividends = $0
$0 + $50 – 0 = $50
If you pay dividends
Here’s a more complex example. To raise capital early on, you sold common stock to shareholders. Now your business is taking off and you’re starting to make a healthy profit. Once your cost of goods sold, expenses, and any liabilities are covered, you have some net profit left over to pay out cash dividends to shareholders. The money that’s left after you’ve paid your shareholders is held onto (or “retained”) by the business.
Let’s use the retained earnings from the example above as our starting point.
Beginning Retained Earnings = $50
Profit/Loss = $10,000
Dividends = $2,000
$50 + $10,000 – $2,000 = $8,050
What’s the difference between retained earnings and net income?
Retained earnings and net income are related, but distinct.
There may be times when your business has a positive net income but a negative retained earnings figure (also called an accumulated deficit), or vice versa. Your net income is what’s left at the end of the month after you’ve subtracted your operating expenses from your revenue. Retained earnings are what’s left from your net income after dividends are paid out and beginning retained earnings are factored in.
Made $50,000 in revenue and have $40,000 in expenses? Your net income for that month is $10,000. However, say you have two shareholders and you gave each of them $6,000 in dividend payouts that month. If we go back to our original equation, we can see that we’re left with a negative retained earnings figure:
Beginning Retained Earnings + Profit/Loss – Dividends = Retained Earnings
$0 + $10,000 – $12,000 = -$2,000
