Retained Earnings Explained Definition, Formula, & Examples

Alternatively, a large distribution of dividends that exceed the retained earnings balance can cause it to go negative. Retained earnings, sometimes, can be negative as well and when a company has a net loss, it has to be recorded in the retained earnings. If this loss is greater than the amount of profits previously recorded as retained earnings, then it is considered to be negative retained earnings.

You can obtain this information from your business’s balance sheet or previous statement of retained earnings. A key advantage of the statement of retained earnings is that it shows how management chooses to redirect the retained earnings of a business. It may indicate that funds are being allocated to the acquisition of more assets, or perhaps sent to investors in the form of dividend payments. Thus, it can provide a general indication of how management wants to use excess funds. As a result, the retention ratio helps investors determine a company’s reinvestment rate.

Uses for the Statement of Retained Earnings

Review the background of Brex Treasury or its investment professionals on FINRA’s BrokerCheck website. Please visit the Deposit Sweep Program Disclosure Statement for important legal disclosures. If you are your own bookkeeper or accountant, always double-check these figures with a financial advisor. Retained earnings can be used to pay off existing outstanding debts or loans that your business owes. To learn more about NetSuite accounting solutions, schedule a free consultation today.

Learn how to find and calculate retained earnings using a company’s financial statements. Creditors view this statement as well, as they want to look at several performance measures before they can issue credit to a company. Low or negative retained earnings indicate that the company may have problems repaying its debt.

How to prepare a statement of retained earnings in 5 steps.

When a business earns a surplus income, it can either distribute the surplus as dividends to shareholders or reinvest the balance as retained earnings. You’ll want to find the financial statements section of a company’s annual report in order to find a company’s retained earnings balance and all the supporting figures you’ll need to complete the calculation. Retained earnings represent a useful link between the income statement and the balance sheet, as they are recorded under shareholders’ equity, which connects the two statements. The purpose of retaining these earnings can be varied and includes buying new equipment and machines, spending on research and development, or other activities that could potentially generate growth for the company. This reinvestment into the company aims to achieve even more earnings in the future.

Since in our example, December 2019 is the current year for which retained earnings need to be calculated, December 2018 would be the previous year. Thus, retained earnings balance as of December 31, 2018, would be the beginning period retained earnings for the year 2019. This is the net profit or net loss figure of the current accounting statement of retained earnings example period, for which retained earnings amount is to be calculated. A net profit would lead to an increase in retained earnings, whereas a net loss would reduce the retained earnings. Thus, any item such as revenue, COGS, administrative expenses, etc that impact the Net Profit figure, certainly affects the retained earnings amount.

Stock Dividend Example

This may result in the creditors choosing not to provide credit to these businesses or charge them a higher interest rate to compensate for the risk. If you’re a small business owner, you can create your retained earnings statement using information from your balance sheet and income statement. Many businesses use retained earnings to pay down debt, which can help to improve a company’s financial health and reduce its interest expenses.

By subtracting the cash and stock dividends from the net income, the formula calculates the profits a company has retained at the end of the period. If the result is positive, it means the company has added to its retained earnings balance, while a negative result indicates a reduction in retained earnings. Retained Earnings are reported on the balance sheet under the shareholder’s equity section at the end of each accounting period.

Additional Resources

The statement of retained earnings is also called a statement of shareholders’ equity or a statement of owner’s equity. The statement is important as it shows the financial health of the company and can help various stakeholders make informed decisions about the company. It also helps track how much profit has been retained over a period and can be an early indicator of potential bankruptcy. This balance sheet ensures that the assets on the books of a company are equal to the sum of the company’s liabilities and stockholder equity. A company releases its statement of retained earnings to the public to raise market and shareholder confidence.

If you have investors to whom you pay dividends, you would subtract the amount of dividends paid in this step. If you own a very small business or are a sole proprietor, you can skip this step. You’ll also need to calculate your net income or net loss for the period for which you are preparing your statement of retained earnings.

Basically, you will list out the values for each part of the retained earnings formula. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. However, if you have one or two investors in your business, you’ll want to list the amount of money distributed to them during this period. We believe everyone should be able to make financial decisions with confidence. Below is a short video explanation to help you understand the importance of retained earnings from an accounting perspective.