How to Calculate Retained Earnings (Even If You’re New to Accounting)
Ever wondered where your business profits go after you’ve paid all your bills?
That leftover amount—when saved instead of spent—is what we call retained earnings. And knowing how to calculate it can help you make better decisions, whether you’re running a side hustle or building a full-blown company.
In this guide, you’ll learn:
- What retained earnings actually are
- Why they’re important for your business growth
- The simple formula to calculate them
- Mistakes beginners often make
- Clear answers to common questions
What Are Retained Earnings? (And Why They Matter to Your Business)
Retained earnings are the profits your company keeps instead of giving them away as dividends. You can use that money to reinvest, pay off loans, or simply build a safety net for the future.
Think of it like your own piggy bank. Every time you earn more than you spend, and choose to save instead of splurge, your piggy bank grows. Companies do the same with retained earnings.
📍 Real-life example:
Let’s say a local bakery earns $10,000 in profit. Instead of taking all that money out, the owner saves $6,000 to buy a new oven next month. That $6,000 becomes part of their retained earnings.
📝 Takeaways:
- Retained earnings = profits kept in the business
- They support growth, stability, and reinvestment
- They show how responsibly a company manages its money
The Retained Earnings Formula (Don’t Worry—It’s Simple)
Here’s the formula you’ll use again and again:
Retained Earnings = Beginning Retained Earnings + Net Income – Dividends
Let’s break that down:
- Beginning Retained Earnings – What you already had saved from previous periods
- Net Income – Profit you made this year (after all expenses and taxes)
- Dividends – What you paid out to shareholders or yourself
Imagine your bank account. You start with a balance, deposit your paycheck (net income), and withdraw some cash for gifts (dividends). What’s left is your new balance—your retained earnings.
How to Calculate Retained Earnings Step by Step
If you’re ready to get hands-on, follow these steps:
✅ Simple Steps:
- Find your starting balance from last year’s retained earnings
- Add this year’s net income
- Subtract dividends paid
- The result = Ending Retained Earnings
A freelance designer begins the year with $5,000 in retained earnings. She earns $20,000 and pays herself $3,000 in dividends.
5,000 + 20,000 – 3,000 = $22,000
That’s her retained earnings at year-end.
Calculating retained earnings is like budgeting for future wins—it tells you what you can afford to invest in next.
3 Beginner Mistakes (and What to Do Instead)
❌ Mistake #1: Confusing retained earnings with cash
Retained earnings are not actual cash. They’re a line on your balance sheet, not your wallet.
❌ Mistake #2: Forgetting about dividends
Dividends reduce retained earnings. Even small payouts add up.
❌ Mistake #3: Ignoring losses
A bad year? That loss shrinks your retained earnings—fast.
✅ Do This Instead:
- Use both your income statement and balance sheet
- Track dividend payouts, no matter how small
- Update your retained earnings regularly
FAQs: What Beginners Ask About Retained Earnings
❓What’s the difference between retained earnings and net income?
Net income is profit for a specific period. Retained earnings are all profits saved since the business started, minus dividends.
Think of net income as one paycheck. Retained earnings? That’s your entire savings.
❓Can retained earnings be negative?
Yes. If your business loses money or pays more in dividends than it earns, your retained earnings can go below zero. This is called an accumulated deficit.
❓Where do retained earnings go on the balance sheet?
Look under the Shareholders’ Equity section. That’s where retained earnings live—right beside things like common stock and capital contributions.
❓How do retained earnings impact business decisions?
They give you flexibility. High retained earnings mean you can fund growth without borrowing. Low ones? You may need to slow down or seek investors.
Conclusion: Take Your First Step Today
Let’s recap what you’ve learned:
- Retained earnings are your business’s long-term savings
- They’re calculated using this formula:
- Tracking them shows how your business is doing—and where it’s going
- Avoiding common myths will help you make smarter decisions
📄 Grab your most recent balance sheet and income statement.
✍️ Do the calculation yourself, even if it’s rough.
It’s not about getting it perfect. It’s about understanding your numbers.
Because when you know your numbers, you lead with confidence.
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