What Are Retained Earnings?

By Taylor Berman
Dec. 4, 2022

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Whether you are a founder, an investor, or an accountant, retained earnings are an important concept to know and understand.

Retained earnings refer to the amount of net income remaining after a company has paid out dividends to its shareholders.

Retained earnings refer to the portion of a company’s earnings after these dividends have been paid out. This is money that can then be reinvested back into the company to help the business grow, whether that is by expanding budgets, increasing production capacity, hiring more employees, buying out competition firms, or launching new products.

Key Takeaways:

  • You can calculate retained earnings if you know the net income or loss, the amount paid in dividends, and the previous period’s retained earnings.

  • Retained earnings are often described in an important document called a retained earnings statement, which can help you make decisions about whether to buy stock in a certain company.

  • Managers and stakeholders benefit from high retained earnings because this allows money to be invested back into the company to make improvements and boost margins.

How to Calculate Retained Earnings

To calculate retained earnings, you will need to know a few things.

First, you need to know your net income or net losses. This is how much money is left over when subtracting costs from revenue. If the result is positive, it is net income. If the result is negative, it is net losses.

Second, you need to know the amount of money paid out to shareholders in the form of dividends. Dividends can be paid out in cash or in stock.

Finally, you will need to know the retained earnings of the previous period. That is, how much money is leftover from the retained earnings of the previous quarter or previous fiscal year.

Retained earnings are calculated with the following formula:

Beginning period retained earnings + net income – dividends paid out (cash or stock)

The number you are left with tells you how much money you can invest back into the company.

Example of Retained Earnings Calculations

Say you started a company at the beginning of 2019. Now, it’s 2020, and you are trying to calculate your retained earnings for the year.

You already know from your balance sheet that your net income is $1,000. You want to reward your stockholders for investing with you, so you decide to split 20% of your profits among them, which comes out to $200.

Because you have just started your business, there are no beginning period retained earnings, so you can go ahead and replace this number with zero.

The formula, when all the numbers are plugged in, then reads:

0 + 1000 – 200 = retained earnings

Your retained earnings for the year 2019 is $800.

Here is another example:

Say your company has been in business for a few years and is starting to make real profits. This year, your net income was $50,000.

You know that stockholders are expecting a 10% dividend of your profits, as you have given them in previous years. So, you set aside $5,000 for them.

Your previous year’s retained earnings, that is, what is left over after having invested back in the company, is $16,000.

Using the formula, you get this result:

16,000 + 50,000 – 5,000 = 61,000

Your retained earnings for the year is then $61,000.

What Is a Statement of Retained Earnings?

A statement of retained earnings is a document prepared by companies that details how much of their net income is going back into the company rather than into the pockets of shareholders.

This can be an important document, especially if you are considering buying stock in a certain company, as it reveals important information about the kind of dividends you can expect and how much the company is investing in new growth.

How to Interpret Results of Retained Earnings Calculations

Having a high amount of retained earnings can be a good sign that the company has the potential to grow and increase its stock value. A company with high retained earnings can use those earnings to grow into new markets, increase productivity, pay off debts, and otherwise increase its profitability.

If a company has high retained earnings and is properly investing those earnings into growing, you can expect their stock value to increase. If a company has high retained earnings, but its stock value is not increasing, it may be a sign that the company is poorly investing its retained earnings.

Why Do Managers and Stakeholders Like to Retain Earnings?

Managers like to retain earnings because it allows them to reinvest money in the company and then allocate funds to where they are needed.

For example, a manager would know when machinery may need to be replaced, when there ought to be an expansion in the sales team, and when a budget expansion may lead to more profits down the road.

Managers would know best where to invest back into the company in order to increase profits.

Stakeholders like to retain earnings for similar reasons. While it may seem counterintuitive, stakeholders also benefit from investing money into the company, even if it would go directly to them.

As the company has increased success and wider profit margins, the stock value of the company goes up. This would increase the value of the stock stakeholders have, which they can then choose to sell.

In this way, they may receive more value from their stock than they would if they had received dividends.

Retained Earnings FAQs

  1. Are retained earnings the same as profit and revenue?

    No, retained earnings are not the same as profit and revenue. Revenue does not take into account the costs of operating a business or the cost of providing shareholders with dividends. Profit, also sometimes called net income, is revenue minus the cost of providing that service or product.

    As described above, retained earnings are how much money is left over from your profits after paying out dividends to your shareholders.

  2. Can retained earnings be a negative number?

    Yes, retained earnings can be a negative number. If your company’s loss is greater than its current amount of retained earnings, your company would be considered to have negative retained earnings.

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Taylor Berman

Taylor Berman is a key contributor to the Zippia content team in charge of editing, fact checking, and maintaining content relevance over time. She enjoys writing articles that help people with their job search and creating stories that inspire people. Taylor earned a bachelor's degree in journalism and public relation with an interest in communications media from Indiana University Of Pennsylvania.

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Topics: Formulas, Glossary