Key takeaways
What this article covers, in order:
- Where retained earnings sits on the balance sheet
- What retained earnings actually means
- How to calculate retained earnings
- Worked example: three years at Northfield Dental Lab
- How to find retained earnings on a balance sheet someone else prepared
- What the retained earnings figure tells you
Retained earnings on a balance sheet is the total profit a company has earned since it started, minus all the dividends it has declared to shareholders. It appears in the equity section, next to share capital, and the formula is: ending retained earnings = beginning retained earnings + net income (or − net loss) − dividends declared.
It is a running scorecard of profit kept in the business, not a pot of money. This guide explains where retained earnings sits, how to calculate it, how to find it on a balance sheet you did not prepare, and the mistakes that most often throw it out.
Where retained earnings sits on the balance sheet
A balance sheet follows the accounting equation: assets = liabilities + equity. Equity is the owners' claim on the business, and for a company it usually has two main parts:
- Contributed capital: what shareholders paid in for their shares (share capital, plus share premium or additional paid-in capital).
- Retained earnings: what the business has earned and kept.
Larger companies may also show other reserves, such as accumulated other comprehensive income or treasury shares, but in a typical small company the equity section is just share capital and retained earnings.
So yes, retained earnings is on the balance sheet, always within equity. It is never an asset and never a liability.
What retained earnings actually means
Every year, a company's net income belongs to its shareholders. They can take some of it out as dividends, or leave it in the company. Whatever they leave in accumulates in retained earnings.
The key point is what happens to that money once it is left in. It does not sit in a separate account. It gets spent on equipment, stock, paying down loans, funding customers who pay late, or simply builds up as cash. Retained earnings tells you how much profit was kept; the asset side of the balance sheet tells you where it went.
How to calculate retained earnings
The calculation runs period by period:
- Start with beginning retained earnings, which is last period's closing figure.
- Add net income from this period's income statement, or subtract a net loss.
- Subtract dividends declared during the period, both cash dividends and stock (share) dividends.
- The result is ending retained earnings, which goes onto the closing balance sheet.
Dividends reduce retained earnings when they are declared, not when they are paid. A dividend declared but still unpaid at year end has already reduced retained earnings, and the unpaid amount sits in current liabilities as dividends payable.
Worked example: three years at Northfield Dental Lab
Northfield Dental Lab is a small company that makes crowns, bridges and aligners for local dental practices. The two founders put in $50,000 of share capital when they started.
Year 1: a loss creates an accumulated deficit
Northfield spent heavily on setup and won its first clients slowly. It made a net loss of $42,000 and paid no dividends.
Ending retained earnings = 0 − 42,000 − 0 = −$42,000.
A negative balance is usually labelled accumulated deficit. On the balance sheet, equity is now $50,000 − $42,000 = $8,000. The owners' original investment has been partly used up by losses.
Year 2: profit wipes out the deficit
Northfield landed a contract with a regional dental group and made net income of $95,000. The founders decided to keep everything in the business.
Ending retained earnings = −42,000 + 95,000 − 0 = $53,000.
Year 3: profit and a dividend
Net income was $130,000. The board declared dividends of $60,000: $40,000 paid during the year and $20,000 declared at year end but not yet paid.
Ending retained earnings = 53,000 + 130,000 − 60,000 = $123,000.
The equity section of Northfield's Year 3 balance sheet reads:
- Share capital: $50,000
- Retained earnings: $123,000
- Total equity: $173,000
The $20,000 unpaid dividend also appears under current liabilities as dividends payable.
Why Northfield has $123,000 of retained earnings but only $31,000 in the bank
Over the three years Northfield bought a $90,000 milling machine and a 3D printer, repaid part of a bank loan, and carried a growing balance of receivables from practices on 30-day terms. All of that was funded from kept profit. Retained earnings records that the profit was earned and kept; it says nothing about whether it is still in cash. This is the single most common misunderstanding about the line.
How to find retained earnings on a balance sheet someone else prepared
Most balance sheets show retained earnings as its own line in equity. If it has been combined with other items, you can work it out:
Retained earnings = total equity − share capital − share premium or additional paid-in capital − other reserves (adding back treasury shares if they are shown as a deduction).
To check the movement for a year, look at the statement of retained earnings or, under IFRS, the statement of changes in equity. It shows the opening balance, profit, dividends and any other changes, and the closing figure should match the balance sheet exactly.
What the retained earnings figure tells you
- A growing balance means the company has been profitable and reinvesting rather than paying everything out.
- An accumulated deficit means cumulative losses exceed cumulative profits. That is normal for an early-stage company, and a red flag for an established one.
- The retention ratio, (net income − dividends) ÷ net income, shows how much of each year's profit is kept. Northfield's Year 3 retention ratio is 70,000 ÷ 130,000, about 54%.
- Retained earnings compared with contributed capital shows how much of the business was built from its own profits rather than owners' cash.
Before declaring a dividend, check your local company law. Many jurisdictions restrict dividends to profits available for distribution, and the rules differ from country to country.
Retained earnings for sole traders and partnerships
Unincorporated businesses do not usually show retained earnings. Profit is added to the owner's capital account (or each partner's account), and money the owner takes out is recorded as drawings, which reduce capital. The idea is the same, profit kept versus profit taken, but the label and the presentation differ.
Common mistakes with retained earnings
- Treating it as cash available to spend. Check the cash line and the cash flow statement for that.
- Recording dividends as an expense. Dividends are a distribution of profit, not a cost of earning it. Putting them in the income statement understates profit and leaves retained earnings wrong by the same amount.
- Reducing retained earnings when a dividend is paid instead of when it is declared. This misstates both equity and liabilities at year end.
- Forgetting the year-end close. In manual books, income and expense accounts must be closed into retained earnings each year. Skip it and next year's opening balance will be wrong, and the balance sheet will not balance.
- Editing the opening balance directly. If last year's retained earnings looks wrong, the cause is usually an error in last year's books. Trace and correct the entry with your accountant rather than overwriting the figure.
hellobooks< / a > -helps">How HelloBooks helps
HelloBooks rolls net income into retained earnings as part of its year-end close, so the opening balance for the new year is carried forward from the ledger rather than typed in. Period locking stops anyone from editing a closed year by accident, and every journal entry, including dividend declarations, can go through an approval step and is kept in the audit trail. The balance sheet and profit and loss report are generated from the same books, so the profit on one always ties to the equity movement on the other. Your accountant can review and approve the close before you rely on the numbers.
