How to Calculate Retained Earnings

One crucial part of your accounting is retained earnings, which are a running tally of the profit you’ve held onto since your founding. If you make a profit, your retained earnings go up, and when you sustain a loss, they go down.

How do you know what your retained earnings are? There’s a simple retained earnings formula available that accounting departments use regularly, but you can use it too if you’re a small business or an investor who wants to know.

Information You Need To Calculate Retained Earnings

First, you need to gather together some critical information:

• A record of your beginning or current retained earnings, which you can easily find on the right side of your company’s most recent balance sheet
• Your net profit or net loss, which is the bottom line on your income statement (and is where the term “bottom line” comes from)
• The dividends you paid out during the period you’re looking at 

Retained Earnings Formula

Learning to calculate your retained earnings is easy when you know the correct formula, which is:

Current Retained Earnings + Profit/Loss – Dividends = Retained Earnings

Let’s do a couple of sample calculations to help you put the retained earnings formula into practice. Say your retained earnings for January are C$10,000, your net profit was C$8,000, and you paid out no dividends. Your retained earnings would look like this:

10,000 + 8,000 – 0 = 18,000

Now, in February, you suffered a net loss of, say, C$2,000. Then things would look like this:

18,000 – 2,000 – 0 = 16,000

In March, you managed to recover very well and earned a net profit of C$20,000. Because of that, you paid C$9,000 in cash out to your three siblings, who are your shareholders. That would look like this:

16,000 + 20,000 – 9,000 = 27,000

In April, the birds sang, and so did your business. You earned another C$20,000 in net profit and decided to issue a five percent stock dividend instead of paying out a cash dividend like you did last month. You had 1,000 shares of outstanding common stock, and their fair market value was C$20 per share. 

This calculation is a little more complicated because you’re going to pay out 50 shares at C$20 apiece. That looks like this:

27,000 + 20,000 – (50 x 20) = 46,000

Now it’s May 1, and your current retained earnings are C$46,000. That number goes up and down from there depending on your profit and loss and whether you pay cash dividends, stock dividends, or none at all.

Retained Earnings vs. Revenue

Both retained earnings and revenue give you a picture of your company’s financial health. However, they look at two different parts of your total financial picture. 

Your revenue is all the money you take in from the sale of your goods and services. This is before any deductions for things like operating expenses, taxes, and other expenses. On your income statement, your total revenue is the top line.

Retained earnings are part of the profit that you hold onto for future use. You could use them to pay extra dividends, fund an expansion, fund new research and development, or invest in your company in other ways. Retained earnings are relative to your net profit or bottom line. 

Retained Earnings vs. Net Income

Retained earnings and net income aren’t the same things, either, although retained earnings do come out of net income. 

Your net income is your income after certain taxes and expenses, such as leases, depreciation, sales gains and losses, and more. You pay taxes on your net income but not on your retained earnings because, as part of your net income, your retained earnings are already taxed.

Also, as the retained earnings formula demonstrates, your retained earnings are your net profit after paying out dividends, too. Essentially, your retained earnings are your company’s profit after you’ve paid out all of these things.

Retained Earnings vs. Shareholder’s Equity and Working Capital

Your shareholder’s equity is how much your company is worth should you liquidate all your assets. Your retained earnings are part of your total equity, and your shareholder’s equity is another part. 

Subtract your total liabilities from your total assets, and you get the number for your total shareholders’ equity.

Working capital is likewise different from retained earnings. It’s how much you have at your disposal to pay for your day-to-day operations. Finding out how much working capital you have involves subtracting your current liabilities from your current assets (as opposed to total liabilities and total assets).

Retained Earnings, Management, and the Board of Directors

You or your company’s management generally decide whether to retain some or all of your earnings or pay your net income out to shareholders. Companies have a certain fiduciary duty to their shareholders regarding net income, but that doesn’t necessarily mean paying out dividends every time.

However, the board of directors and shareholders may decide to forgo dividends for various reasons depending on your plans. Perhaps you have an expansion project in the hopper, and your shareholders prefer that you pursue that instead of paying them. In that case, you’ll retain more earnings to fund that project.

There may also be times when you and your shareholders decide that paying out more dividends is the better path and vice versa. Usually, though, you’ll pursue a more balanced approach between payouts and retaining some of your earnings. 

Retained Earnings Statement

Sometimes, you might decide to create a separate retained earnings statement in addition to including it on your balance sheets. You might also combine it with your income statement. 

Doing either of these things helps show your shareholders and other stakeholders where your retained earnings are going. Everyone can see how much is going to investors, how much is going towards investment in your company, and how much is staying put. 

Over the long term, positive retained earnings can show that you’re in good financial health. By the same token, a trend showing negative retained earnings can indicate that you’re suffering financial problems. 

A retained earnings statement also demonstrates how much money gets paid out in dividends–either cash or stock–each quarter, ensuring you’re fulfilling your fiduciary duties responsibly.

Using Retained Earnings

We’ve briefly touched on ways you can use your retained earnings. However, doing so is a bit more involved than what we’ve discussed so far.

Mergers and Acquisitions

Many companies use some of their retained earnings for mergers and acquisitions or perhaps developing new partnerships. Every one of these things can improve your company’s current situation and prospects. 

Mergers, acquisitions, and partnerships are expansion opportunities and can help numerous companies work together to streamline their operations. That, in turn, can help improve prospects across the industry and not just among the companies involved.

Repay Outstanding Debt

Your debt burden can serve as an indication of your business’s financial health, too. In some ways, having business debt is like having personal debt. A certain amount is okay, but when you can show an ability to pay it down quickly, you increase your credit rating, giving you opportunities for loans with better terms in the future.

One way you can use your retained earnings is to pay down your outstanding debt. You shouldn’t deplete retained earnings to pay down debt, but using some for this purpose is an excellent idea. 

Reinvestment

Reinvesting in your company is a fantastic way to use your retained earnings. You can expand your production lines or services and, thus, hire more people. Paying your employees bonuses or giving them raises is another way you can reinvest in your company.

You can also fund new projects, expand into new markets, or develop new product variants. For instance, perhaps you manufacture camping equipment, and you want to try expanding your line of tent lanterns into decorative lanterns for people’s households. You can use some of your retained earnings for that.

Stock Buybacks

Some large corporations use retained earnings to repurchase their own stocks from the markets. It effectively reduces the number of shares in the market and drives up their price.

They do this for a variety of reasons. They might feel the market has undervalued their share price, or they’re trying to improve specific financial ratios (the metrics that investors use to determine a company’s worth). 

They also do it because it can improve their overall position in the market, bringing them more profit when they resell those shares.

Keep in mind that stock buybacks are a controversial practice because they can artificially inflate a company’s share price. Many people also see them as a waste of money because they believe the company could put that money to better use, like investing in its workforce and supply chain. 

Limitations on Retained Earnings

Retained earnings as one of your financial metrics has its limitations, though. Over time, they show certain trends about how much money you have and can hold onto. Investors want to know more than that, though, such as whether reinvesting or paying out those earnings would yield higher returns or put the company in a safer position. 

Retained Earnings to Market Value

This is one of the financial ratios we mentioned above. Retained earnings to market value tell investors how well a company manages its earnings. 

Over the course of a couple of years, investors look at your retained earnings versus the changes in your stock price. For instance, subtracting dividends from earnings per share tells investors how much earnings per share a company has held onto.

From there, they can determine how much value per share your company has generated over a given period. If you decide to use more of your retained earnings to pay down debt, you don’t create as much value per share over time. 

To be sure, this only examines the value your company creates concerning its share price and retained earnings. It doesn’t look at the full value you’ve created.

FAQs

We have answers to a few of the most frequently asked questions about retained earnings out there.

What Do High or Low Retained Earnings Mean For a Company?

It’s easier to assess a company’s financial health when they have low or negative retained earnings. Companies in those situations are generally experiencing some type of financial trouble.

High retained earnings make assessing financial health a little more complicated. On the surface, it appears that the company has a track record of strong profits over several years. 

On the other hand, it could show that the company is having problems finding worthwhile ventures to put some of its retained earnings into. They might not expand when they should, or perhaps they’ve laid off a lot of workers in recent years without really streamlining anything. 

So while low or negative retained earnings paint a clear picture, you need to delve a little deeper into what a company with high retained earnings is doing to see how financially healthy they are.

How Do You Calculate the Percentage Increase In Retained Earnings?

Calculate your current retained earnings using the retained earnings formula. If you had retained earnings of C\$10,000 at the start of a specific accounting period, had a net income of C\$4,000, and paid out C\$2,000 in dividends, your current retained earnings are C\$12,000.

Subtract your beginning retained earnings from your current retained earnings, divide the result by your beginning retained earnings, and multiply by 100:

12,000 – 10,000 = 2,000

2,000 ÷ 10,000 = 0.2

0.2 x 100 = 20

Your retained earnings increased by 20 percent over the period at which you’re looking.

Final Thoughts

Knowing how to calculate your retained earnings is an integral part of keeping track of your business’s finances. It gives you a picture of your financial health and tells you how much money you have for new projects, expansion, and dividends. 

Fortunately, finding out your retained earnings, along with how much they increase and decrease over various accounting periods, isn’t hard. Once you know how to use the retained earnings formula, you can draw a very detailed picture of your company’s finances.