Calculate Retained Earnings
Retained earnings are an essential part of the financial well-being of a company. When you calculate retained earnings, you get a better idea of how much your business has to re-invest in itself. Our guide will take you through retained earnings, including what they are and how to calculate them.
How Do You Prepare a Retained Earnings Statement?
Your retained earnings balance sheet can be either a standalone document or something attached to the regular balance sheet at the end of the accounting period. As with other financial records and statements, the retained earnings statement is represented by an equation.
The statement starts with the retained earnings as reported at the start of the financial period. The statement then lists balance adjustments based on any changes to cash dividends, stock dividends, and net income. The statement ends with the calculated retained earnings balance at the end of the financial period. The closing balance for one period is the opening balance for the next.
We’ll go more into how to calculate retained earnings later.
What Makes up Retained Earnings?
Retained earnings are the total amount of net income remaining after a company pays dividends to shareholders. Businesses generate revenues that are either positive or negative – profits and losses.
A positive balance gives business owners and company managers some room to use the extra money left over. The profits are often paid out to shareholders, but you can choose to instead re-invest it in the company for expansion and growth. Any money not paid to shareholders is considered retained earnings and used when you calculate retained earnings.
Retained earnings form the portion of profits that is held (retained) from the accounting period and used in the future. Retained earnings go towards things like paying shareholder dividends and paying for business expansions.
Retained earnings are similar to net income rather than gross income because they represent the total income saved by a company. Shifts in net income can affect retained earnings balance. Things such as increases or decreases in revenue and losses can impact the profitability of a business. Anything that affects net income also affects retained earnings.
Examples of things that affect net income and retained earnings are depreciation, sales revenue, and the cost of goods sold.
How Do You Calculate Retained Earnings on the Balance Sheet?
The following are some steps to guide you through how to prepare your retained earnings balance sheet. Please note that you, or your accountant, will need the income statement and balance sheet for this.
- Prepare The Heading
Include a three-line heading to the top of the balance sheet. The business name goes at the top. The middle line is the document title. Call the document something like “Retained Earnings Statement.” The bottom line is for the accounting period the document covers. Put “For the third quarter of 2018” here or something similar.
- Record the Balance from the Previous Year
The balance from the previous year goes in the first line. If you’ve already prepared one of these statements in the past, you’ll carry over the ending balance of that sheet as the beginning balance of this sheet. If this is your first retained earnings statement, then the starting balance is zero.
For our example, we’ll say you had $10,000 in retained earnings the previous year. So your first line would be;
Beginning Retained Earnings Balance; $10,000
- Add The Net Income
Find the net income on the income statement. If you have a net loss instead, you’ll want to subtract it from your starting balance.
Let’s continue our example and say your business made $8k in the prior year.
Beginning Balance: $10,000
Plus: Net Income: $8,000
- Subtract Stockholder Dividends
Does your business maintain a dividend policy? If so, then subtract dividends paid out over the accounting period. If you don’t have dividends, then you don’t need to take anything away.
Opening Balance: $10,000
Plus: Net Income: $8,000
Minus: Dividends $3,000
Keep in mind that dividends are always treated as a reduction or debit even if they aren’t paid out.
- Calculate the Total
Once you’ve subtracted any dividends, you’ll be left with the final retained earnings for the financial period. That number is the starting point for the next balance sheet. If we stick to our example, the total amount of retained earnings would be $15,000 (10,000+8,000-3,000).
To summarize, the retained earnings formula is Initial Balance + Net Income (or – Net Losses) – Cash Dividends – Stock Dividends.
Keep in mind that retaining earnings won’t always be a positive balance. You can end up with negative retained earnings if you lose more money than you gain or pay more in dividends than income retained.
Critical points of implementation
There are several ways businesses can take advantage of retained income. Here are some of the critical implementations of retained earnings;
- You can distribute the money among business owners and shareholders as dividends, either partially or fully
- You can use the money to invest in expanding the business, such as increasing product range and inventory capacity and hiring new staff
- Businesses can use the money to launch new products or variants of an existing one. For example, if you sell white goods, you can go from selling refrigerators to also selling air conditioners. If you make and sell food, you can invest in new flavors or varieties.
- You can use the money for acquisitions, mergers, and partnerships
- You can use the money to buy back shares from investors
- You can use the money to pay off existing debts to improve overall financial health.
Retained earnings represent the money left over at the end of an accounting period. How businesses use that money is up to them, but there are plenty of ways to take advantage of having extra cash. Invest in future success, new products, services, or keep the money for a rainy day. So long as everyone gets the money they are entitled to, anything left over is yours to do with as you want.