How to Calculate Retained Earnings: Formula and Example

Accountants use the formula to create financial statements, and each transaction must keep the formula in balance. This bookkeeping concept helps accountants post accurate journal entries, so keep it in mind as you learn how to calculate retained earnings. If you use it correctly, an income statement will reveal the total net income of your business by calculating the difference between your assets and liabilities. This document is essential as you learn how to calculate retained earnings and other equities. Dividend payments can vary widely, depending on the company and the firm’s industry.

Income statement sample

1. But when you stockpile earnings and manage your money well, you can live above panic and grow your business while others are shrinking.
2. They didn’t have retained earnings, and it was just common sense that they should.
3. Such items include sales revenue, cost of goods sold (COGS), depreciation, and necessary operating expenses.
4. Retained earnings are found in the balance sheet easily when the balance sheet is prepared for each ending accounting period.
5. Retained earnings are actually reported in the equity section of the balance sheet.

Lower retained earnings can indicate that a company is more mature, and has limited opportunities for further growth, but this isn’t necessarily a negative. Retained earnings being low indicates that much of the company’s profits are paid out to shareholders in dividends. For newer companies looking to expand, it’s common to see higher retained earnings, since they will focus on reinvesting profit into the business. Retained Earnings are listed on a balance sheet under the shareholder’s equity section at the end of each accounting period. To calculate Retained Earnings, the beginning Retained Earnings balance is added to the net income or loss and then dividend payouts are subtracted.

Calculating this figure is vital for demonstrating the long-term profitability of a business over its lifespan. A negative figure could mean a company has become uncompetitive or isn’t spending its income wisely. Negative figures in this regard are often seen as a red flag for potential bankruptcy.

Retained earnings are related to net (as opposed to gross) income because they are the net income amount saved by a company over time. Though cash dividends are the most common payout, remember that stock dividends are another option. Unlike cash payments, stock dividends don’t immediately impact a company’s bottom line. Revenue is the income a company generates from business operations during a period, while retained earnings are the accumulated net income that was not paid out as dividends to shareholders to date. Let’s walk through an example of calculating Coca-Cola’s real 2022 retained earnings balance by using the figures in their actual financial statements.

But for a more clear view of the owners, the retained earnings statement is prepared for looking into the history of how a business has performed during the time. Retained earnings are the amount that is left after paying out dividends to stockholders, and the owners could reinvest this amount or payout to shareholders. The figure is calculated at the end of each accounting period (monthly/quarterly/annually).

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Your cash balance rises and falls based on your cash inflows and outflows—the revenues you collect and the expenses you pay. But retained earnings are only impacted by your company’s net income or loss and distributions paid out to shareholders. There is no change in the shareholder’s when stock dividends are paid out, however, you’ll need to transfer the amount from the retained earnings part of the balance sheet to the paid-in capital. The amount transferred to the paid-in capital will depend upon whether the company has issued a small or a large stock dividend. Retained earnings at the beginning of the period are actually the previous year’s retained earnings.

Real Company Example: Coca-Cola Retained Earnings Calculation

Let’s say your company’s dividend policy is to pay 50 percent of its net income out to its investors. In this example, $7,500 would be paid out as dividends and subtracted from the current total. We can cross-check each of the formula figures used in the retained earnings calculation with the other financial statements.

How to calculate retained earnings – Formula, examples and video

1. Check out six common small-business money mistakes and how you can turn them around—or completely avoid them—and enjoy steady success.
2. You can find your business’s previous retained earnings on your business balance sheet or statement of retained earnings.
3. Net Income is the profit your company made during the current period after all expenses have been deducted from revenues.
4. As an important concept in accounting, the word “retained” captures the fact that because those earnings were not paid out to shareholders as dividends, they were instead retained by the company.
5. Retained earnings are calculated by adding/subtracting, the current year’s net profit/loss, to/from the previous year’s retained earnings, then subtracting dividends paid in the current year from the same.

We can find the net income for the period at the end of the company’s income statement (consolidated statements of income). Retained earnings are actually reported in the equity section of the balance sheet. Although you can invest retained earnings into assets, they themselves are not assets. Your retained earnings account is $0 because you have no prior period earnings to retain. For example, we say that the company pays dividends for 25% of its net income.

The money that’s left after you’ve paid your shareholders is held onto how to calculate retained earnings (or “retained”) by the business. On one hand, high retained earnings could indicate financial strength since it demonstrates a track record of profitability in previous years. On the other hand, it could be indicative of a company that should consider paying more dividends to its shareholders. This, of course, depends on whether the company has been pursuing profitable growth opportunities. Profits give a lot of room to the business owner(s) or the company management to use the surplus money earned.

Another example of retained earnings calculation

Since you’re thinking of keeping that money for reinvestment in the business, you forego a cash dividend and decide to issue a 5% stock dividend instead. First, you have to figure out the fair market value (FMV) of the shares you’re distributing. Companies will also usually issue a percentage of all their stock as a dividend (i.e. a 5% stock dividend means you’re giving away 5% of the company’s equity). If dividends are rising at a proportionally larger amount each year compared to net income, the retention ratio will decrease. That’s an indicator the business is focusing less on growth—because more money is going to shareholders and less is being reinvested. Generally speaking, a company with a negative retained earnings balance would signal weakness because it indicates that the company has experienced losses in one or more previous years.