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How To Calculate Retained Earnings: Formula and Steps

Eric Rosenberg • March 19, 2024

Calculating retained earnings

Retained earnings (RE) is a finance and accounting concept that explains how much money a business keeps after all expenses and owner payments. It refers to money the business keeps to pay for future expenses, owner dividends, and investing in business growth.

Knowing how to calculate retained earnings is fundamental for businesses of all sizes. Here’s a look at what retained earnings means for freelancers and entrepreneurs to help you understand how this concept influences your business.

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What are retained earnings?

So, what is retained earnings for a business? Retained earnings are funds a business keeps after paying all expenses and payments to owners, like dividends. Retained earnings are an important metric for business owners, including small businesses and freelancers, planning for the economic future of their business.¹

Wherever you are in your entrepreneurial journey, whether you’re a part-time gig worker or a side hustler, knowing how to calculate retained earnings can be very helpful.

Why retained earnings are important

Retained earnings are essential to businesses, including solo entrepreneurs, for several reasons:

  • Financial stability: The first reason to keep cash in the bank and retain earnings is to provide financial stability in case of a down period. Seasonal businesses may need some money to cover the off-season. Others may need to weather an economic downturn or cover bills after losing a large client. Just as individuals and families should keep an emergency fund, businesses should keep retained earnings to cover emergencies and unexpected financial needs.
  • Investing in growth: Owners may want to use retained earnings to reinvest in the business. That could be hiring workers, buying new equipment, or increasing marketing to attract new customers.
  • Equity and debt transactions: Larger businesses may use cash for more extensive financial needs. Those could include paying off debt, repurchasing ownership (as stock) from investors, or even buying another business. While these are more common for more mature companies, planning for larger transactions can be advantageous.
  • Future bonuses: Retained earnings can eventually turn into future bonuses. Business owners can leverage bonuses to pay off personal debt, build savings, or invest for retirement.

Retained earnings formula explained

There are a few ways to look at retained earnings. Here is the retained earnings formula so you know how to calculate retained earnings and where to find them on your financial statements.

Retained earnings formula for a single financial period

Retained earnings for a single financial period are straightforward to calculate if you maintain financial records using a trusted bookkeeping or accounting system. With most accounting apps, you can find retained earnings on your financial reports without doing any extra math. If you’re calculating it manually, here’s the retained earnings formula for a single financial period, whether a month, quarter, or year:

Retained earnings = Net income (or Loss) – Dividends

Net income represents the business’s income or loss when subtracting all expenses from a business’s revenue. Net income is another term for profit.

Dividends are payments made to shareholders, including a solo business owner.²

Ongoing net retained earnings formula

It’s helpful to know your retained earnings for single financial periods and the business’s net retained earnings, or total retained earnings, over time. Here’s the retained earnings formula used for ongoing calculations, like what you see on a company’s balance sheet.

Retained earnings = Beginning retained earnings + Net income (or Loss) – Dividends

You’ll likely notice that this formula is identical to the calculation for one period with a single difference. In this case, you take the total retained earnings from the start of the business and update it to find the total retained earnings since the company’s founding.

Adding or subtracting the most recent retained earnings from the ongoing total gives you the updated number.

Retained earnings example

Here’s an example walking you through how to calculate retained earnings for a freelancer or other small business.

Let’s say Pat is a freelancer who earned $6,000 last month and spent $4,000 on business expenses and taxes, including their monthly payroll from the business. That gives Pat a Net income, or profit, of $2,000.

Net income = $6,000 Revenue – $4,000 Expenses

Net income = $2,000

Most months, Pat likes to take an owner dividend, which Pat uses for savings and investments. This month, Pat took a $500 payment from the business, leaving $1,500 in retained earnings.

Retained earnings = Net income – Dividends

Retained earnings = $2,000 – $500

Retained earnings = $1,500

For the month we’re analyzing, Pat’s freelance business maintained retained earnings of $1,500.

Steps for calculating retained earnings

If you’re calculating retained earnings for your business from scratch, here are the steps you would follow. Even if a business isn’t registered with the state as an LLC or corporation, the steps to calculate retained earnings are the same.

Determine the initial retained earnings balance

To calculate net retained earnings, start by finding the initial retained earnings balance. Look at the most recent balance sheet in the equity section, typically at the bottom of the balance sheet, to find a line for retained earnings.

Identify the net income (or loss) for the current period

Next, find the net income for the current accounting period. If a business uses bookkeeping and accounting software, net income is the “bottom line” of the profit and loss statement or income statement, so the figure will likely be near the bottom.

To calculate it manually, you would start with revenue for the accounting period and subtract all expenses.

Identify dividends distributed to shareholders in the quarter or year

Finally, find the dividends distributed to shareholders or owners during the accounting period. These are often called “owner draws” or “member draws” for sole proprietorships and single-member LLCs. If you’re the sole owner, any profit distributions made to you outside of paychecks would be considered dividends to calculate retained earnings.

If you run financial statements from bookkeeping software, you’ll probably find dividends or a similar line item at the bottom of the income statement below the line for net income.

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The ideal amount of retained earnings

There is no perfect number for retained earnings that applies to all businesses. As a general rule, as businesses grow, they need more retained earnings to cover the company’s ups and downs.

For a small business, you can think of retained earnings as a combination of a business emergency fund and a business growth fund, often stored in a dedicated savings account. Keeping your funds in a segregated high-yield savings account could work well if you’re a sole proprietor.

Consider measuring your retained earnings goal in terms of how much cash you may need to get through a rough patch, like three to six months. If you have additional goals to reinvest, adding that goal to your emergency fund could lead to an ideal retained earnings target.

Retained earnings go beyond the bottom line

In corporate life, quarterly earnings are a primary financial focus. However, for smaller businesses, retained earnings could be just as important.

If you’re not sure what else to do with your retained earnings and finances as a solo business owner, learn more about financial planning for freelancers.

FAQs

What are negative retained earnings?

Negative retained earnings happen when a business has more cash outflows than inflows. This could lead to business debt, which isn’t necessarily bad. However, sustained negative retained earnings over a long period of time can lead to financial troubles.

How do you calculate net income from retained earnings?

Calculating net income from retained earnings involves working backward through a company’s financial results. Add dividends to retained earnings to find the net income for an accounting period.

What’s the difference between retained earnings and revenue?

Revenue is the cash a business brings in from all sales and operations before accounting for costs. Revenue is often called a business’s “top line” financial result. Retained earnings represent a business’s cash after subtracting expenses and payments to the business owners.

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¹ Information from Cornell Law's "Retained earnings" as of February 26, 2024: https://www.law.cornell.edu/wex/retained_earnings

² Information from Yeshiva University's "How to Calculate Retained Earnings (Formula and Examples)" as of February 26, 2024: https://online.yu.edu/syms/blog/how-to-calculate-retained-earnings-formula-and-examples

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