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How to Calculate Retained Earnings + Examples

Your business might not be profitable in its formative years, leaving you with no option but to push ahead.

Once you’re in the green, however, you may not want to start rewarding yourself with your company’s profits just yet. There’s still plenty of room for growth — many entrepreneurs continue reinvesting earnings back into the company for years.

If you plan on keeping those earnings in the business for reinvestment, you’ll need to know how to calculate your retained earnings.

What are Retained Earnings?

Retained earnings are all the net income/profits you have left after paying out dividends or distributions to owners/shareholders. If you’re the sole owner, that means any profits left over after you pay yourself from the company.

Businesses often leave some money in their retained earnings to save for emergencies, maintain working capital, launch new products, pay down business debt, and seize investment/expansion opportunities.

Retained earnings are also helpful in calculating your business’s book value, the net value of all your business’s assets. If you were to liquidate your company today, your total payout to all shareholders would be approximately equal to your book value.

Retained earnings usually show up on the balance sheet, but some companies prepare a separate Statement of Retained Earnings for increased clarity.

In terms of your financial accounts, retained earnings have a normal credit balance because it’s part of owner’s equity. Credit entries increase the account, while debit entries decrease it.

Calculating Retained Earnings

Here’s the retained earnings formula:

RE = Beginning RE +/- Net Profit/Loss - Dividends/Distributions

Where RE = retained earnings.

Let’s explain the other portions.

  • Beginning RE: Also known as your current RE. This is your retained earnings balance at the beginning of the period. This is equal to the previous period’s ending retained earnings (which you’re calculating with this formula), so you can pull this from the last period’s balance sheet. 
  • Net Profit/Loss: Your remaining income left after all your expenses, but before paying out dividends and distributions. You can pull this from your income statement in your accounting software.
  • Dividends/distributions: Profits that the company pays out to shareholders. The more shares you have in the company, the larger your dividend or distribution.

In most cases, your accounting software can handle the retained earnings calculation for you. However, it never hurts to know how to perform these calculations by hand.

With that in mind, let’s look at some examples of calculating retained earnings.

Retained Earnings in Action

Retained Earnings With no Dividend

For the sake of example, imagine you launched a side business on January 1st of 2021. Since you’re just opening your doors, you have no retained earnings. Your current retained earnings are $0.

You make some sales and manage to earn $2,000 in profits. Being a new business, you don’t want to pay out any dividends or distributions. This number would be $0.

Let’s plug the numbers into the formula.

RE = Beginning RE +/- Net Profit/Loss - Dividends/Distributions

RE = $0 + $2,000 - $0 = $2,000

Thus, your retained earnings are $2,000.

This is simple enough to understand. You started with nothing, earned $2,000 in profits, and kept it all in the business.

Retained Earnings and Cash Dividends

Continuing with the example above, say you just finished your second month in business. Thanks to some word-of-mouth marketing, you managed to pull in $5,000 in profits.

You need to supplement your main income this month, so you decide to pay yourself $1,500 in cash dividends out of your profits.

Recall that your retained earnings at the end of last month were $2,000. That $2,000 is now your beginning/current retained earnings. Thus, you’ll plug in $2,000 to that part of the formula.

Here’s how the formula would look:

RE = Beginning RE +/- Net Profit/Loss - Dividends/Distributions

RE = $2,000 + $5,000 - $1,500 = $5,500

Your retained earnings would now be $5,500.

Retained Earnings and Stock Dividends

Companies with multiple shareholders will sometimes give out stock dividends instead of cash dividends. This simply involves sending every shareholder more shares of stock in lieu of cash when you pay out dividends.

Stock dividends require us to do a bit more work and adjust our formula a bit. We have to figure out how much those shares are worth in terms of fair market value (FMV) to make our retained earnings formula work.

You’ll also need to figure out how many shares you’re giving away. Many companies will say they’re giving away X% of their company as stock dividends — you have to calculate how many shares X% represents.

The new formula looks like this:

RE = Current RE +/- Net Profit/Loss - (# of shares x FMV per share)

Time for an example.

Recall that your current retained earnings are $5,500

Now, imagine that your business growth is exploding. You brought on some shareholders and now have 1,000 shares of outstanding stock. You also calculated that each share is worth $5.

You doubled February’s net profit, earning $10,000 in March. Such growth makes you realize that you want to dump as much money as possible back into the company. Therefore, you decide to issue a 10% stock dividend — 100 shares — instead of a cash dividend.

RE = $5,500 + $10,000 - ([1,000 * 10%] x $5) = $15,000

Your RE would be $10,500 for the beginning of April.

The Bottom Line

Retained earnings are a key number to know. Keeping a handle on retained earnings helps you make decisions about business investments, product/service launches, dividend payments, and much more.

 

Of course, there’s no need to calculate and keep track of retained earnings manually when you have accounting software like ZarMoney on your side. Try ZarMoney for free today.

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