How to Calculate Retained Earnings on a Balance Sheet

by Fraser Sherman; Updated June 30, 2018

When your company makes a profit, you can issue a dividend to shareholders or keep the money. The profits you keep are called retained earnings. You can use retained earnings as working capital, to pay off debt or buy assets such as equipment or real estate. When you prepare your financial statements, you have to calculate retained earnings and report the total on the balance sheet.

Shareholders' Equity

The balance sheet gets its name because it's an equation: owners' equity plus the company's liabilities equals the company assets. The two sides of the equation have to balance. Owners' equity or shareholders' equity is what's left after you subtract all the liabilities from the assets. If, say, the business has $250,000 in assets and $125,000 in liabilities, the shareholders' equity is $125,000.

Accountants break down equity into several different categories such as

  • Common stock
  • Preferred stock
  • "Other comprehensive income" such as foreign-currency transactions
  • Retained earnings

Calculating Retained Earnings

The retained earnings formula is simple. Suppose you're making out the third-quarter balance sheet. Take the second quarter retained earnings, add the company's net income for the third quarter, subtract dividends and you're there.

For example, assume you started the quarter with $400,000 in retained earnings. Your income statement shows the net income for the third quarter is $75,000. You issue $25,000 in dividends to the stockholders. That leaves you with a total $450,000 in retained earnings, which you report on the balance sheet. That becomes the initial retained earnings for Q4.

It's possible the Q3 retained earnings can go negative. If you declared a $100,000 dividend, your retained earnings would be -$25,000. If you suffer large losses, you may have to dip into the retained earnings to pay for them.

How Much to Retain?

Calculating returned earnings is simple. Figuring out how much you want to retain is more complicated. Retaining earnings is important if you expect the company will need money in the near future. Owners, however, may demand a return on their investments. One reason for negative retained earnings is when owners insist the company deliver a larger dividend than the period's net income.

Many companies adopt a retained earning policy so investors know what they're getting into. For example, you could tell investors that you'll pay out 40 percent of the year's earnings as dividends or that you'll increase the amount of dividends each year as long as the company keeps growing. If you're a start-up, your policy might be to pay no dividends until your debt is below a certain level.

Things Needed

  • Calculator

About the Author

Over the course of his career, Fraser Sherman has reported on local governments, written about how to start a business and published four books of film reference. He lives in Durham NC with his awesome wife and two wonderful dogs.

bibliography-icon icon for annotation tool Cite this Article