Retained Earnings: Formula, Example, and Statement

Retained earnings are the cumulative profits a company has kept instead of paying out as dividends. You calculate them with one formula: beginning retained earnings plus net income minus dividends equals ending retained earnings. The figure lives in the equity section of the balance sheet and grows every period the company earns more than it distributes.

For a controller or CFO, retained earnings is the number that ties the income statement to the balance sheet. If it does not reconcile, your books do not close. This guide walks through the formula, a worked example, the statement that reports it, and the mistakes that throw it off.

What are retained earnings?

Retained earnings are the portion of cumulative net income a company has reinvested in the business rather than returned to shareholders as dividends. It is an equity account, not a cash account, and it carries forward from one accounting period to the next. A profitable company that pays no dividends will see retained earnings climb year after year; a company with losses larger than its past profits can post negative retained earnings, called an accumulated deficit.

Retained earnings formula

The formula is short and it is the same for every company:

Net income comes straight off the income statement. Dividends are the amount declared during the period, whether or not they have been paid in cash yet. The result is what you report in equity.

Worked example

Suppose a company starts the year with $180,000 in retained earnings. It earns $95,000 in net income and declares $30,000 in dividends. Ending retained earnings are $180,000 plus $95,000 minus $30,000, which equals $245,000. That $245,000 becomes next year's beginning balance. If the company had instead posted a $40,000 net loss and paid no dividends, retained earnings would fall to $140,000.

Where retained earnings appear on the balance sheet

Retained earnings sit in the shareholders' equity section, below paid-in capital. Together with common stock and additional paid-in capital, they make up total equity. Because the account rolls the income statement forward into the balance sheet, it is the bridge that keeps the accounting equation, assets equal liabilities plus equity, in balance. Your trial balance should show the ending retained earnings figure once the books are closed. A generated set of GAAP-style financial statements will pull the same number into both the balance sheet and the statement of retained earnings automatically.

The statement of retained earnings

The statement of retained earnings is a short financial statement that shows the movement in the account over a period. It opens with the beginning balance, adds net income, subtracts dividends and any prior-period adjustments, and ends with the closing balance. Public companies usually fold it into a broader statement of stockholders' equity, while smaller businesses often present it as a standalone schedule between the income statement and the balance sheet.

How closing entries create retained earnings

Retained earnings do not update on their own during the year. Revenue and expense accounts collect activity, and at period end the closing entries sweep net income into retained earnings and zero out the temporary accounts. Dividends declared are also closed against retained earnings. This is why a mid-year trial balance shows the prior year's retained earnings while the current year's profit still sits in the income statement accounts.

Retained earnings vs net income

Net income is a single period's result. Retained earnings are the running total of every period's net income minus every dividend ever paid. A company can have strong net income this year yet modest retained earnings if it has paid out most of its profits over time.

Are retained earnings the same as cash?

No. Retained earnings are an equity balance, not a pile of cash. A company can hold $2 million in retained earnings and very little cash if those profits are tied up in inventory, equipment, receivables, or debt repayment. Retained earnings tell you how much profit has been reinvested; the cash flow statement and the bank balance tell you what liquidity is actually on hand. Confusing the two is one of the most common errors owners make when they assume high retained earnings mean money is available to spend.

Can retained earnings be negative?

Yes. When cumulative losses and dividends exceed cumulative profits, the account turns negative and is reported as an accumulated deficit. Startups often carry a deficit for years while they scale, and it is not automatically a red flag. It becomes a concern only when the trend keeps deepening without a path to profitability.

What can a company do with retained earnings?

Retained earnings fund reinvestment: buying equipment, paying down debt, funding research, acquiring another business, or building a cash reserve. The board decides each period how much profit to retain and how much to distribute. Companies in growth mode tend to retain almost everything, while mature companies with fewer reinvestment options return more through dividends and buybacks.

Keeping the number clean

Retained earnings only stay accurate if the numbers feeding it are accurate, and that starts with clean payables. Misclassified expenses, duplicate bills, and missed accruals all distort net income, which then distorts retained earnings. Automating invoice capture and coding through accounts payable automation software keeps expense recognition consistent, so the profit that rolls into equity is the real one. When the source data is right, the close is faster and the balance sheet ties out the first time.