Retained Earnings Guide: How to Calculate Retained Earnings

Retained earnings are the net income from a company’s historical profits retained after paying out dividends to its shareholders. A business can then store its retained earnings in a special account and invest the surplus back into the company to pay off loans, launch a new product, or expand its current operations.

For bookkeeping purposes, a statement of retained earnings is included as a line item on a company’s balance sheet—a financial document that shows a company's current assets, liabilities, and stockholders' equity—or cash flow statement, under the shareholders’ equity section.

The decision to pay out dividends or retain earnings usually falls on the business owner, company management, or a stakeholder vote. The decision to retain the earning surplus will largely depend on the business’s and shareholders’ short- and long-term goals and dividends policy. If the business pays out dividends, it may make its investors happier in the short run, but it will result in an outflow of capital.

If the business reinvests its earnings back into the company, it increases the possibility of larger future dividend payouts. Often, a business will choose to pay out nominal dividends with part of its net earnings—the amount of income left over after subtracting all business expenses from its total revenue—and then reinvest in business operations with the remaining retained earnings.

Here are a few examples of how retained earnings can work for companies with shareholders:

1. 1. No retained earnings due to dividends: An e-commerce bookseller has a majority group of shareholders interested in short-term profits. At the end of each financial quarter, the shareholders all vote for the company’s net income to be paid out in the form of dividends (either as cash or common stock) depending on the number of shares that each stakeholder owns, resulting in no retained earnings.
2. 2. No retained earnings due to net loss: A rental company has a particularly bad financial quarter and operates at a net loss for a specific period, generating no profit. As a result, they are unable to either pay dividends or add funds to their retained earnings account.
3. 3. Medium retained earnings: A small business selling cupcakes wants to please its shareholders while still growing the company. This financial quarter, it decides to pay out a small number of dividends to its stakeholders and retain a portion of its accumulated earnings for reinvestment to continue strengthening its financial health.
4. 4. High retained earnings: A growth-focused tech company attracts shareholders interested in long-term gains rather than short-term economic profits. Each financial quarter, the tech company decides not to pay out common stock or cash dividends to its shareholders. Instead, it builds a large retained earnings balance to invest in new products and software to improve efficiency. The shareholders support this financial model, hoping that the high cumulative retained earnings of the company will result in higher dividends in the future, increasing the long-term profitability of the investment.

Here’s a formula to calculate a company’s retained earnings for a particular financial quarter:

Retained earnings = Net income – cash and stock dividends

To use this retained earnings formula, you’ll first need to calculate the amount of net income (also called net profit) for the company, which equals its total revenue (usually the cost of goods sold) minus total expenses (like operating expenses or material costs). Once you know the net income for the particular accounting period, you’ll be able to subtract any dividends paid out to determine the retained earnings.

Since retained earnings are cumulative, you can also factor in the prior year’s retained earnings (also called beginning period or beginning balance retained earnings) to calculate a company’s total retained earnings balance in the current year:

Total retained earnings = Beginning retained earnings + net income – dividends

In microeconomics, retained earnings and revenue are related concepts with very different applications. They differ in:

1. 1. Variables: Retained earnings and revenue use different formulas to calculate different amounts of money for a company. Retained earnings are the net income after dividends have been distributed, while revenue is simply the amount of income a company generates before subtracting expenses and costs.
2. 2. Uses: Retained earnings and revenue are used in very different ways. Revenue is a more general number (displayed at the top of a company’s balance sheet, income statement, or other financial statements) used to determine how much income a business’s operations generate over time. It doesn’t accurately represent how much money the business has on hand. Retained earnings calculations are much more granular (displayed in the stockholders’ equity section of the balance sheet), subtracting costs and dividend payments to determine how much money the company has to reinvest in its operations.
3. 3. Relationship: Since revenue is a much more general number, it will always be significantly larger than retained earnings, which subtract costs and dividends to come to a smaller and more precise figure.

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