Accounting and bookkeeping
Retained earnings (RE)
Retained earnings represent the cumulative net profits a business has kept since its inception, after paying out any dividends or distributions to its owners or shareholders.
What is Retained earnings?
Retained earnings are the financial lifeblood of your growing business. When you make a profit at the end of a financial year, you have a choice. You can distribute that money to yourself and other owners as dividends, or you can keep it in the company. The portion you keep becomes your retained earnings. This figure accumulates over time, adding each year's net profit and subtracting any net losses or dividends paid. It sits in the equity section of your balance sheet. For a new freelancer or a local trading shop, a positive balance shows that your business has historically generated more money than it has spent or given away. It provides a cushion for tough times and a pool of funds to buy new equipment, hire staff, or expand operations.
Beginning Retained Earnings + Net Income - Dividends Paid
A positive result means your business has accumulated surplus profits over its lifetime. A negative result indicates historical losses exceed profits, known as an accumulated deficit.
How Retained earnings works
The process begins at the end of your accounting period when you finalise your profit and loss statement. First, you determine your net profit or loss by subtracting all expenses from your total revenue. Next, you decide if you will distribute any of that profit to the owners. Once dividends are paid, the remaining profit transfers to the balance sheet. This amount is added to the beginning retained earnings balance from the previous period. If the business suffered a loss, that loss is subtracted instead, which can sometimes result in a negative balance called an accumulated deficit. Over the years, this continuous cycle builds a historical record of your unspent profits.
- Calculate your total net profit or loss for the current accounting period.
- Subtract any dividends or owner drawings distributed during the year.
- Identify the beginning retained earnings balance from your previous balance sheet.
- Add the new retained amount to the beginning balance to find the total.
- Record this final accumulated figure under the equity section of your balance sheet.
Worked example
Gulf Trading Supplies started the year with 15,000 in retained earnings. During the financial year, the company generated 80,000 in total revenue and incurred 50,000 in operating expenses, resulting in a net profit of 30,000. The owners decided to distribute 10,000 as dividends to themselves. To calculate the new balance, they take the starting balance of 15,000, add the 30,000 net profit, and subtract the 10,000 in dividends. The final retained earnings balance at the end of the year is 35,000. This new figure will appear on their updated balance sheet.
Why it matters for your business
Tracking retained earnings is vital because it measures your long-term financial stability. A healthy balance means you do not have to rely on expensive bank loans or outside investors to fund your next phase of growth. It gives you the working capital needed to survive seasonal dips or unexpected market changes. If you want to apply for a business loan, lenders will scrutinise this number to see if your company is historically profitable. Paper & Pen posts journal entries automatically, ensuring your retained earnings are always accurate on your balance sheet. Keeping a close eye on this figure helps you balance rewarding yourself today against securing the future of your enterprise.
Questions
Common questions
Are retained earnings the same as cash?
Can retained earnings be negative?
Related terms
- Balance sheet A balance sheet is a financial statement that reports a company's assets, liabilities, and shareholder equity at a specific point in time to provide a snapshot of its overall financial health.
- Profit and loss statement A profit and loss statement is a financial report that summarises a company's revenues, costs and expenses during a specific period to show whether it generated a profit or incurred a loss.
- Net profit margin Net profit margin is a financial ratio that shows the percentage of revenue remaining after all operating expenses, taxes and interest have been deducted from your total sales.
- Working capital Working capital is the financial metric representing the difference between a business's current assets and its current liabilities, indicating its short-term liquidity and operational efficiency.
- General ledger A general ledger is the master accounting record of a business, containing all financial transactions categorised by account to track assets, liabilities, equity, revenue and expenses.
- Accounts payable Accounts payable is the total amount of short-term debt your business owes to suppliers and vendors for goods or services that you have received but have not yet paid for.