Retained Earnings: Definition, Purpose, How to Calculate and Examples

Retained earnings or retained earnings (RE) is part of the net income on the company’s income statement which is not paid as dividends. These retained earnings is often reinvested in the company, such as through research and development, equipment replacement, or debt reduction.

Below, you will find the definition, the formula for calculating retained earnings and some of its implications for businesses and investors.

Table Of Contents

1 What is Retained Earnings?
2 What is the Purpose of Retained Earnings?
3 How to Calculate Retained Earnings?
3.1 Retained Earnings at the beginning of the Period
3.2 Retained Earnings at the End of Period
4 How Does Net Income Affect Retained Earnings?
5 How Do Dividends Affect Retained Earnings?
6 Examples of Calculation of Retained Earnings in Business
7 Retained Earnings Limit

What is Retained Earnings?

Retained Earnings (RE) is the accumulated portion of business profits that are not distributed as dividends to shareholders but are kept for reinvestment into the business.

Usually, these funds are used for working capital and the purchase of fixed assets (capital expenditures) or allocated to pay off debt obligations.


Retained earnings are reported on the balance sheet or balance sheet under the shareholder equity section at the end of each accounting period. To calculate RE, the initial RE balance is added to net income or reduced net loss and then dividend payments are subtracted.

A summary report called the statement of retained earnings is also maintained, which outlines the changes in RE for a given period.

What is the Purpose of Retained Earnings?

Retained earnings have a useful relationship between the income statement and balance sheet because they are recorded under shareholder equity, which links the two statements.

The purpose of withholding this revenue can vary and include purchasing new equipment and machinery, spending on research and development, or other activities that have the potential to generate growth for the company. This reinvestment into the company aims to achieve more revenue in the future.

If a company does not believe it can earn a sufficient return on investment from those retained earnings (that is, earns more than their cost of capital), then they will often distribute the earnings to shareholders as dividends or undertake share repurchases.

How to Calculate Retained Earnings?

The formula for calculating retained earnings (RE) is as follows:

RE = Initial Period RE + Net Profit – Cash Dividend – Share Dividend

Where RE = Retained Income

 Early Retained Earnings

At the end of each accounting period, retained earnings are reported on the balance sheet as accumulated income from the previous year (including current year income), less dividends paid to shareholders.

In the next accounting cycle, the ending balance of RE from the previous accounting period will now be the beginning balance of retained earnings.

The RE balance is not always a positive number, because it can reflect that the net loss for the current period is greater than the initial RE balance. Alternatively, a large dividend distribution that exceeds retained earnings may cause it to be negative.

End of Period Retained Earnings

At the end of the period, you can calculate the final retained earnings balance for the balance sheet by taking the initial period, adding the net profit or net loss, and subtracting dividends.

How Does Net Income Affect Retained Earnings?

Any change or movement with net income will have a direct impact on the RE balance. Factors such as an increase or decrease in net profit and the onset of a net loss will pave the way for the profitability or deficit of the business.

Retained Earning accounts can go negative due to large cumulative net losses. Naturally, the same items that affect net income affect RE.

Examples of these items include sales revenue, cost of goods sold, depreciation, and other operating expenses. Non-cash items such as impairment or impairment and share-based compensation also affect the account.


How Do Dividends Affect Retained Earnings?

The distribution of dividends to shareholders can be in the form of cash or shares. Both forms can reduce the value of RE to the business.

Cash dividends are cash outflows and are recorded as a reduction in the cash account. This reduces the size of the balance sheet and the value of the company’s assets because the company no longer owns a portion of its liquid assets.

Stock dividends, however, do not require a cash outflow. Instead, they reallocate a portion of the RE to common stock and additional paid-in capital accounts. This allocation does not affect the size of the company’s overall balance sheet but decreases the value of shares per share.

Example of Calculation of Retained Earnings in Business

In this example, we don’t know the amount of dividends paid by XYZ, so using information from the Balance Sheet and Income Statement, we can get it by remembering the formula Beginning RE – End RE + Net Profit (-loss) = Dividend


In the picture above we know:

  • Awal Periode RE: $ 77.232
  • End of RE period: $78,732
  • Net Income: $5,297

So, $77,232 – $78,732 + $5,297 = $3,797

Dividend paid = $3,797

We can confirm that this is true by applying the formula Beginning of period RE + Net profit (loss) – dividends = End of RE

Then we have $77,232 + $5,297 – $3,797 = $78,732, which is our figure for the end-of-period RE

Retained Earnings Limit

As with many measures of financial performance, the calculation of retained earnings must be taken into context. Analysts should assess the general situation of a company before placing too much value on the company’s retained earnings — or its accumulated deficit.

If the company has been operating for several years, an accumulated deficit may signal the need for financial assistance. For established companies, problems with retained earnings should be a big red flag for any analyst.

On the other hand, a new business usually takes several years to get out of the debt it takes to get started. Accumulated deficits in the first few years of a company’s life may not be troubling, and can even be expected.

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