Retained Earnings Explained: Formula, Calculation Methods, and Practical Examples for Students
What Are Retained Earnings in Accounting?
Retained earnings represent the cumulative profits a company keeps after paying dividends to shareholders. Instead of distributing all profits, businesses reinvest a portion back into operations, expansion, debt repayment, or asset purchases. Retained earnings appear in the shareholders’ equity section of the balance sheet and increase over time if the company remains profitable.
Main Retained Earnings Formula
The basic retained earnings formula is:
Ending Retained Earnings = Beginning Retained Earnings + Net Income − Dividends
This formula shows how profits and dividend payments affect the company’s accumulated earnings.
Practical Example 1: Basic Calculation
Assume the following:
Beginning Retained Earnings = $25,000
Net Income for the Year = $12,000
Dividends Paid = $5,000
Now apply the formula:
Ending Retained Earnings = 25,000 + 12,000 − 5,000
Ending Retained Earnings = $32,000
This means the company reinvested $7,000 of its profit ($12,000 − $5,000) into the business.
Alternative Formula Using Net Loss
If the company incurs a loss, the formula becomes:
Ending Retained Earnings = Beginning Retained Earnings − Net Loss − Dividends
Example:
Beginning Retained Earnings = $20,000
Net Loss = $4,000
Dividends = $2,000
Ending Retained Earnings = 20,000 − 4,000 − 2,000
Ending Retained Earnings = $14,000
Losses reduce retained earnings.
Retained Earnings from Income Statement
Sometimes you calculate retained earnings in two steps:
Step 1:
Net Income = Revenue − Expenses
Step 2:
Ending Retained Earnings = Beginning Retained Earnings + Net Income − Dividends
Example:
Revenue = $50,000
Expenses = $35,000
Net Income = 50,000 − 35,000 = $15,000
Beginning Retained Earnings = $10,000
Dividends = $3,000
Ending Retained Earnings = 10,000 + 15,000 − 3,000
Ending Retained Earnings = $22,000
Why Retained Earnings Matter
Retained earnings indicate long-term profitability and growth potential. Increasing retained earnings show reinvestment and financial stability, while negative retained earnings (accumulated deficit) may signal financial difficulties.
Key Takeaways
Retained earnings represent accumulated profits kept in the business. The main formula is Beginning Retained Earnings plus Net Income minus Dividends. Losses and dividends reduce retained earnings. Strong retained earnings support reinvestment and long-term growth.