What Are Retained Earnings? Meaning and Formula

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Retained earnings are the cumulative net income a company has earned since it began operating, minus all the dividends it has declared to shareholders over that time. The figure appears in the shareholders’ equity section of the balance sheet. It answers one question: of all the profit the business has generated, how much has it kept rather than paid out? Retained earnings are a running total that carries forward from one period to the next, not a single year’s result. They are also a source of financing recorded on the equity side, not a pile of cash.

What retained earnings mean in business

When a company earns a profit, the money belongs to its owners. The company can pay some or all of it out as dividends or keep it in the business. The record of everything kept since inception is the retained earnings balance. Other names include retained profits, earned surplus, accumulated profits and the profit and loss reserve. In UK-style accounts, the “profit and loss account carried forward” (P&L c/f) serves the same function. The concept is the same, though presentation differs by jurisdiction and company type.

Retained earnings belong to corporations, where ownership is held through shares and profit is distributed through dividends. Sole proprietorships and partnerships usually do not report a separate retained earnings line. Profits and withdrawals flow directly through the owners’ capital accounts.

How retained earnings work

The accounting flow

During a period, a company records revenues and expenses in temporary accounts that feed the income statement. At period end, those accounts are closed. Revenues and expenses net out to net income or net loss, and that result is transferred into retained earnings. Dividends declared during the period are also closed into retained earnings, reducing it. The temporary accounts start the next period at zero. Retained earnings, a permanent account, keeps its balance.

This is why retained earnings do not appear on the income statement. Net income is the bridge: the income statement measures one period’s profit, and retained earnings accumulate it on the balance sheet.

Retained earnings carry a normal credit balance, like other equity accounts. Net income increases the balance (a credit), while net losses and dividends decrease it (debits). When debits have exceeded credits over the company’s life, the account shows a debit balance, which is the accumulated deficit.

What affects the balance

Any item that changes net income changes retained earnings, because net income flows in at the end of each period. That includes revenue, cost of goods sold, operating expenses, depreciation, interest and income tax. Beyond net income, the main movements are:

• Cash dividends declared on common and preferred stock.
• Stock dividends, which move an amount out of retained earnings into contributed capital accounts.
• Prior period adjustments, such as corrections of material errors in previously issued statements. These are recorded directly to the opening retained earnings balance rather than run through the current year’s income statement.
• Cumulative effects of certain accounting changes, where the rules require retrospective application and an adjustment to opening retained earnings.
• Share repurchases and retirements, in some cases. Depending on how a company accounts for retired shares and the jurisdiction’s rules, part of the cost of buying back stock can be charged against retained earnings.

Retained earnings formula

The basic formula is:

Ending retained earnings = Beginning retained earnings + Net income (or − Net loss) − Cash dividends − Stock dividends

Where:

• Beginning retained earnings is the prior period’s ending balance.
• Net income or loss comes from the current period’s income statement.
• Cash dividends are dividends declared during the period, on both preferred and common shares.
• Stock dividends are the amount transferred out of retained earnings when the company distributes additional shares.

Because each period starts from the prior period’s ending figure, an error carries forward until corrected, which is why corrections go through opening retained earnings.

Presenting the calculation: “add” and “less”

Many companies, and most coursework, show the movement in a statement of retained earnings or as a column in the statement of changes in shareholders’ equity:

The “Add” and “Less” labels make the direction of each item obvious. Without them, readers have to infer signs from parentheses. A net loss appears as “Less: Net loss” or as a figure in parentheses.

Worked example (hypothetical)

Northfield Tools Inc. starts the fiscal year with retained earnings of $500,000. It has 100,000 common shares outstanding with a par value of $1 each. During the year:

• Net income is $180,000.
• The board declares cash dividends of $0.60 per share, or $60,000.
• Later, the board declares a 10% stock dividend, distributing 10,000 new shares when the market price is $12 per share.

Step 1: Add net income. $500,000 + $180,000 = $680,000

Step 2: Subtract cash dividends. $680,000 − $60,000 = $620,000

Step 3: Subtract the stock dividend. Under US GAAP, a small stock dividend (generally one below roughly 20% to 25% of outstanding shares) is recorded at the shares’ fair value. Here that is 10,000 shares × $12 = $120,000. Of that amount, $10,000 (10,000 × $1 par) goes to common stock and $110,000 goes to additional paid-in capital. $620,000 − $120,000 = $500,000 ending retained earnings

Northfield earned $180,000, yet its retained earnings ended exactly where they started. The cash dividend sent $60,000 out of the company. The stock dividend sent nothing out: the $120,000 was reclassified within equity from retained earnings to contributed capital. Total shareholders’ equity rose by the $180,000 of net income and fell only by the $60,000 cash dividend. A large stock dividend would generally be recorded at par value, so less would leave retained earnings.

Retention ratio. Counting only the cash dividend, Northfield kept $120,000 of its $180,000 profit:

Retention ratio = (Net income − Dividends) ÷ Net income = $120,000 ÷ $180,000 ≈ 66.7%

The dividend payout ratio is the complement: $60,000 ÷ $180,000 ≈ 33.3%. The two always sum to 100% when calculated on the same inputs. Analysts usually compute these ratios with cash dividends, because a stock dividend does not distribute resources.

Where retained earnings appear on the balance sheet

Retained earnings sit in the shareholders’ equity section, typically below the contributed capital lines (common stock, preferred stock and additional paid-in capital) and near items such as accumulated other comprehensive income and treasury stock. The balance sheet identity shows where they fit:

Assets = Liabilities + Shareholders’ equity

Shareholders’ equity divides broadly into money owners put in (contributed capital) and profit the business earned and kept (retained earnings). Retained earnings are thus part of the owners’ claim on assets, built from profits rather than from share issuance.

Is retained earnings an asset?

No. Retained earnings are an equity account, not an asset. They sit on the claims side of the balance sheet and describe where some of the company’s resources came from. The assets side describes what those resources are now.

The confusion arises because retained earnings can fund asset purchases. If a company keeps $2 million of profit and spends it on a new production line, the equipment is recorded as property, plant and equipment. Retained earnings still show the $2 million as a source of financing. The two are opposite sides of the same transaction.

Retained earnings vs. cash

A company can have large retained earnings and very little cash, or plenty of cash and an accumulated deficit.

Hypothetically, a manufacturer reports $5 million of retained earnings but only $300,000 in its bank account. Over the years, the kept profit has been spent on machinery, used to build inventory, extended to customers as receivables and used to pay down a loan. None of those uses lowers the retained earnings balance.

There is also a timing difference. Net income is measured on an accrual basis, so revenue counts when earned even if the customer has not paid. A company can therefore add profit to retained earnings before the related cash arrives. To see how much cash operations actually generate, look at the cash flow statement and measures such as free cash flow.

The cash and retained earnings difference matters for dividends. A large retained earnings balance does not mean a company can afford a dividend, because dividends are paid in cash. In many jurisdictions, corporate law also restricts distributions based on legal capital or solvency tests rather than on retained earnings alone.

Retained earnings vs. dividends

Cash dividends move resources out of the company. On declaration, retained earnings decrease and a dividends payable liability is recorded. On payment, the liability is settled and cash decreases. The company ends with fewer assets and less equity.

Stock dividends distribute additional shares instead of cash. The amount leaves retained earnings and moves into common stock and additional paid-in capital, so total equity does not change and no assets leave the business. Each shareholder owns more shares, but the same proportion of the company. The market price per share tends to adjust for the larger share count: in a 100% stock dividend, the share count doubles and the price would be expected to fall by about half, all else equal.

Preferred dividends also reduce retained earnings when declared. For cumulative preferred stock, undeclared dividends in arrears are not recorded as a liability or a reduction of retained earnings until declared, though they are disclosed. Common shareholders’ share of retained earnings is effectively subordinate to preferred dividend claims.

Different company profiles lead to different patterns. A growth-focused company with many promising projects may pay little or no dividend and fund research and development, marketing, working capital, capital expenditures and acquisitions from retained profit, so its retained earnings build up. A mature company with fewer high-return opportunities may distribute more of its profit, keeping retained earnings growth modest. Neither pattern is inherently better. The right choice depends on what the company can earn on money it keeps compared with what shareholders could earn elsewhere.

Retained earnings vs. revenue, profit and net income

Revenue is the top line of the income statement: what the company earned from selling goods and services during a period, before costs and expenses. Some industries call it gross sales. Revenue says nothing about whether the company made money.

Net income (net profit) is the bottom line: revenue minus every cost, expense, interest charge and tax for the period. It measures one period’s profitability.

Retained earnings are the cumulative total of net income, across all periods, less all dividends ever declared. They connect to net income, not revenue.

Profit and retained earnings differ in two ways. First, profit is for one period, while retained earnings are a lifetime total. Second, retained earnings are after dividends, while profit is before them. A company can report a positive profit this year while its retained earnings balance falls, if dividends declared exceed the year’s net income. Likewise, a company with a large retained earnings balance can report a loss in a given year.

Retained earnings vs. common stock and paid-in capital

Common stock, additional paid-in capital and retained earnings all sit within shareholders’ equity, but they come from different places.

• Common stock and additional paid-in capital record what investors paid the company for shares. Common stock usually carries the par value, and additional paid-in capital records the excess paid above par.
• Retained earnings record what the company earned and kept through operations.

Common stock is not part of retained earnings. The two meet only in transactions such as stock dividends. Keeping them separate shows whether a company has grown by issuing shares or by earning and keeping profit.

Appropriated and unappropriated retained earnings

Retained earnings are often divided into two types:

• Appropriated retained earnings are portions the board has formally set aside for a specific purpose, such as a planned expansion, a contract or loan covenant that limits distributions, or a legal reserve requirement.
• Unappropriated retained earnings are the remainder, available for general use, including future dividends.

An appropriation does not move cash or create a separate fund. It signals that the earmarked portion is not available for dividends. Many companies now disclose restrictions in the notes instead, but the terms remain common in coursework and in some jurisdictions’ reporting.

What retained earnings can be used for

Strictly, it is the resources generated by kept profit that get used, not the accounting balance itself. Broadly, surplus profit can go to:

1. Dividends to shareholders, either all or part of the profit. Once paid, the money leaves the company permanently.
2. Expansion of existing operations, such as adding production capacity or hiring more salespeople.
3. New products or markets, such as an appliance maker moving into air conditioners or a snack maker launching new flavors.
4. Mergers, acquisitions and partnerships that improve the company’s prospects.
5. Share buybacks, which return capital to shareholders by reducing the share count.
6. Debt repayment, which lowers future interest costs and strengthens the balance sheet.

Funding growth from retained profit is internal financing. It avoids the costs of issuing new shares (such as underwriting fees and dilution of existing owners) and the interest and covenants that come with borrowing.

Management’s role

Management, under the board, normally decides how much profit to retain, since the board declares dividends. Shareholders influence that policy through their votes, including by electing directors. In a smaller private company, owners and directors may be the same people.

Reasons to retain more include promising projects, high-interest debt to pay down, or a cushion against downturns. Reasons to distribute more include shareholders who rely on regular income or a lack of attractive internal uses. Many companies do both, paying a steady dividend while retaining part of each year’s profit.

What retained earnings can tell you

Looked at over several years, retained earnings show how much profit a company has generated and kept, and how that changes. A balance that grows steadily points to sustained profitability combined with a retention policy. A balance that stalls despite reported profits points to distributions keeping pace with earnings. A falling balance means losses, distributions above earnings, or both.

The figure is most useful when read alongside other information:

• Net income and dividends for each year, to see what drove the change.
• The cash flow statement, to see whether kept profit turned into cash and how it was spent.
• Return measures such as return on equity, to judge whether the growing equity base is earning a good return.
• Industry context, since capital-intensive businesses tend to reinvest heavily, and some sectors face regulatory limits on distributions.

High retained earnings

A high balance can reflect a long record of profitability. It can also raise a question: if the company has not found good uses for the profit, would shareholders be better off receiving more of it?

Negative retained earnings (accumulated deficit)

When cumulative losses and distributions exceed cumulative profit, retained earnings turn negative, and the line is usually labeled accumulated deficit. The cause matters:

• Early-stage and growth companies often show deficits because they spend heavily on development and customer acquisition before reaching profitability. Here, the deficit records past losses.
• Struggling companies may show a deficit from repeated losses. A deficit that keeps growing in a mature business is a warning sign.
• Profitable companies can still show a deficit if distributions to shareholders, which can include amounts charged against retained earnings for share repurchases, exceed accumulated profit. Apple, for example, reported an accumulated deficit of $19.1 billion at the end of its fiscal 2024 (September 2024) and $14.3 billion at the end of fiscal 2025 (September 2025), despite being one of the most profitable companies in the world.

The income statement history and the equity statement show which situation applies.

Retained earnings to market value

Analysts can test how well a company has used the profit it kept by comparing the rise in its share price with the earnings it retained over the same period, usually several years. The measure asks how many dollars of market value each retained dollar created.

Calculation (hypothetical figures):

• Share price at start of period: $40
• Share price at end of period: $52
• Total diluted earnings per share over the period: $9.00
• Total dividends per share over the period: $3.00

Retained earnings per share = $9.00 − $3.00 = $6.00 Price increase = $52 − $40 = $12 Market value created per retained dollar = $12 ÷ $6.00 = 2.0

In this example, each dollar the company kept is associated with $2 of share price gain. A result above 1 suggests the market valued the retained profit at more than its book amount. A result below 1 suggests the opposite.

Read the ratio with care. Share prices respond to interest rates, sentiment, industry trends and expectations, so the ratio associates the two figures without proving causation. It also ignores value returned through dividends and depends on the period chosen.

Limitations of retained earnings

• No information on returns. Even a multi-year trend only shows how much profit is being added, not whether it earned more than shareholders could have earned elsewhere. Return on equity, return on invested capital and the market value test above help answer that.
• Not cash, not liquidity. The balance says nothing about the company’s ability to meet obligations or pay dividends.
• Shaped by accounting choices. Depreciation methods, revenue recognition, impairments, restatements and the treatment of buybacks all affect the balance. Comparisons across companies with different policies or accounting frameworks need adjustment.
• History, not forecast. The balance reflects past performance and past decisions. A company with a large balance can still face a weak future.
• Investor preferences differ. Some shareholders would rather receive larger dividends than see retained earnings rise each year, so a growing balance is not automatically good news for every owner.

FAQs

The Bottom Line

Retained earnings matter to investors and students reading a corporate balance sheet, because the figure shows how much profit a company has kept over its life. The balance is equity and is not cash, so it cannot show whether the company can pay a dividend or earn a good return. Read it alongside net income, dividends, the cash flow statement and return on equity.