How to Calculate Retained Earnings on A Balance Sheet

calculating retained earnings balance sheet

Calculating retained earnings on a balance sheet can be confusing and overwhelming, especially for business owners and investors who aren't familiar with financial statements. The process involves more than just adding and subtracting numbers, it requires a deep understanding of a company’s financial health and its ability to reinvest profits for growth.

Without properly calculating retained earnings, it's easy to miss key insights into a company’s performance in managing its profits and planning for the future. This article will guide you through how to calculate retained earnings on a classified balance sheet or a standard one, helping you understand this crucial step in financial analysis.

What are Retained Earnings?

Retained earnings are the part of a company's net income that is retained and not distributed to shareholders as dividends. Instead, these earnings are reinvested into the business or used to pay off debt. Retained earnings are a key component of a company's equity and appear on the balance sheet under the shareholders' equity section.

In simple terms, retained earnings represent the profits that have been reinvested in the company instead of being paid out, and they are listed on the balance sheet under shareholders' equity.

What is a Balance Sheet?

A balance sheet is one of the three fundamental financial statements that provide a clear picture of a company's financial position at a specific point in time. It details the company's assets, liabilities, and shareholders' equity, offering a clear overview of what a business owns and owes. The balance sheet is divided into two main sections: assets on one side and liabilities and equity on the other.

Assets include everything the company owns, such as cash, inventory, property, and equipment, and they are categorized into current assets (which can be converted into cash within a year) and non-current assets (long-term investments or property).
Liabilities represent what the company owes, including short-term debts (current liabilities) and long-term debts (non-current liabilities).
Equity shows the shareholders' stake in the company, including retained earnings, capital invested by owners, and other equity items.

The balance sheet follows the fundamental accounting equation: Assets = Liabilities + Equity, ensuring that the total value of what the company owns is balanced by what it owes and the value that belongs to the owners.

How to Calculate Retained Earnings on a Balance Sheet?

Retained earnings represent the total net income that a company has kept over time, instead of paying it out as dividends to shareholders. Calculating retained earnings is essential for understanding a company's financial health and is reflected in the equity section of the balance sheet. Here is how to calculate retained earnings on the balance sheet:

1- Start with Beginning Retained Earnings

Firstly, you need to determine the beginning retained earnings for the period. This is the retained earnings balance at the end of the previous period, which will be carried over to the new period.

2- Add Net Income

Next, include the current period's net income or loss. This is usually found on the income statement. If the company made a profit, you add the net income; if there was a loss, subtract it.

3- Subtract Dividends Paid

If the company paid dividends to shareholders during the period, subtract the total amount of dividends paid. This represents the portion of the net income that was distributed to shareholders rather than retained in the business.

4- Calculate the Ending Retained Earnings

The final retained earnings figure is calculated by adding net income and subtracting dividends from the beginning retained earnings balance. This represents the company’s cumulative profits that are reinvested or held in the business.

Formula:

Ending Retained Earnings = Beginning Retained Earnings + Net Income − Dividends Paid

Example of Calculating Retained Earnings on A Balance Sheet

Let's assume that a company's balance sheet for the year ending December 31, 2025, includes the following data:

Retained Earnings (Beginning of Period) (January 1, 2025): $500,000
Net Income for the Year (2025): $120,000
Dividends Paid in 2025: $40,000

Now, let's calculate the retained earnings at the end of the year (December 31, 2025):

The formula for retained earnings on a balance sheet is:

Retained Earnings (End of Period) = Retained Earnings (Beginning of Period) + Net Income − Dividends Paid

Retained Earnings (End of Period) = 500,000 + 120,000 − 40,000 = 580,000

Thus, the retained earnings on the balance sheet at the end of 2025 would be $580,000. This figure reflects the cumulative profit that the company has retained over the years, adjusting for any dividends paid out in the current period.

Importance of Calculating Retained Earnings

Calculating retained earnings is crucial for assessing a company's financial stability, growth potential, and management of profits. Retained earnings reflect how much profit a company has reinvested into its operations rather than distributing it to shareholders. This metric is often used by investors, analysts, and stakeholders to evaluate the company's ability to fund its expansion, pay off debt, and support future initiatives without relying heavily on external financing.

Warren Buffett stresses the importance of CEOs mastering capital allocation, particularly when it comes to retained earnings. He explains that profitable companies generate cash that must be wisely deployed, and the CEO is ultimately responsible for making these decisions. In fact, after ten years, a CEO could be responsible for managing more than 60% of a company's capital simply through decisions related to retained earnings. Buffett warns that many CEOs, lacking capital-allocation skills, may turn to external help—such as consultants or investment bankers—but this often exacerbates the problem rather than solving it.

In addition, Buffett provides key "rules of thumb" for managing retained earnings: they should be positive, grow consistently (even during recessions), and stock buybacks should be offset by adding treasury stock to neutralize their impact. These insights emphasize that effective management of retained earnings is critical for long-term business success, highlighting the significant role CEOs play in ensuring the company’s financial health.

Streamline Calculating Retained Earnings on a Balance Sheet With Enerpize

Enerpize Accounting Software is an intuitive and efficient solution designed to streamline financial management for businesses of all sizes. With its user-friendly interface, Enerpize automates key accounting processes, including tracking business expenses, generating financial reports, and managing cash flow.

Enerpize simplifies the process of calculating retained earnings on a balance sheet by automating key financial tasks. The software integrates seamlessly with your business's financial data, automatically updating and calculating retained earnings by subtracting dividends from net income and adding the result to the existing balance. This eliminates manual errors, ensuring accuracy and saving valuable time. With this online accounting software, you can easily track and manage the growth of retained earnings, helping your business make informed financial decisions and maintain a clear picture of its financial health.

Key Takeaways

Retained earnings are the portion of net income that is kept within the business rather than paid out as dividends.
The calculation of retained earnings involves starting with the beginning balance, adding net income, and subtracting any dividends paid.
Retained earnings reflect a company’s ability to reinvest profits for growth, debt reduction, and expansion.
Accounting Software helps streamline the process of calculating retained earnings by automating key financial tasks, reducing errors, and saving time.

calculating retained earnings is easy with Enerpize.