Retained earnings are the cumulative profits a company has kept in the business instead of distributing them to shareholders. They appear in shareholders’ equity on the balance sheet. Retained earnings are not a cash account: the money may already have been used for inventory, equipment, debt repayment, or other assets.
Retained earnings formula
The standard calculation is:
Ending retained earnings = Beginning retained earnings + Net income − Dividends
If the business reports a net loss, use the loss as a negative amount. Owner withdrawals in a corporation are normally recorded as dividends or distributions, depending on the entity and tax treatment.
Worked example
| Component | Amount |
|---|---|
| Beginning retained earnings | $120,000 |
| Net income for the year | $48,000 |
| Dividends declared | ($18,000) |
| Ending retained earnings | $150,000 |
The company added $30,000 to retained earnings during the year. That does not mean it has $150,000 in the bank. The balance represents accumulated accounting earnings retained since the company began, after distributions and applicable adjustments.
Where retained earnings appear
Retained earnings are reported in the equity section of a corporation’s balance sheet. The statement of retained earnings—or the statement of shareholders’ equity for a larger company—reconciles the beginning and ending balances.
The flow is:
- Revenue and expenses produce net income or net loss on the income statement.
- Net income closes into retained earnings at period end.
- Dividends reduce retained earnings.
- The ending balance appears in shareholders’ equity.
To see how closing entries move through ledgers, review our T-account examples.
Retained earnings vs. cash, revenue, and net income
| Term | What it measures | Financial statement |
|---|---|---|
| Revenue | Income generated from selling goods or services before expenses | Income statement |
| Net income | Profit for one reporting period after recognized expenses | Income statement |
| Retained earnings | Cumulative profit kept after dividends | Balance sheet/equity statement |
| Cash | Money currently available in bank accounts or on hand | Balance sheet/current assets |
A profitable company can have weak cash flow if customers have not paid their invoices. That is why retained earnings should be reviewed with cash flow and accounts receivable.
Can retained earnings be negative?
Yes. Negative retained earnings are commonly called an accumulated deficit. They may result from startup losses, several unprofitable years, large dividends, write-downs, or prior-period corrections. A negative balance does not automatically mean bankruptcy, but it deserves investigation.
Ask three questions:
- Are losses temporary or recurring?
- Is the company producing operating cash flow?
- Were distributions made even though the business needed capital?
How to interpret retained earnings
There is no universally “good” retained earnings balance. A growing company may retain most profits to fund expansion. A mature company may distribute more cash because it has fewer attractive projects. Capital-intensive companies generally need more reinvestment than asset-light businesses.
Useful comparisons include:
- Trend over time: Compare the balance and the change for several years.
- Retention ratio: (Net income − dividends) ÷ net income, when net income is positive.
- Return on retained earnings: Growth in earnings compared with profits retained, used cautiously over several years.
- Cash-flow support: Confirm that accounting earnings are producing cash rather than only expanding receivables.
Our year-over-year growth guide explains how to compare financial metrics without mixing periods.
Common retained earnings mistakes
- Calling retained earnings “cash reserves.”
- Subtracting dividends paid during the period without checking whether accounting records use dividends declared.
- Ignoring a prior-period adjustment or accounting change.
- Assuming a higher balance is always better.
- Using retained earnings as a substitute for a cash-flow forecast.
Practical month-end checklist
- Reconcile revenue, expenses, assets, and liabilities.
- Confirm net income agrees with the finalized income statement.
- Record declared dividends or distributions correctly.
- Post closing entries and review the equity accounts.
- Reconcile beginning retained earnings to the prior period’s ending balance.
- Document any correction or adjustment separately.
Frequently asked questions
Are retained earnings an asset?
No. Retained earnings are part of shareholders’ equity. They explain a source of equity, not where the related resources are currently held.
Do retained earnings increase with a debit or credit?
Retained earnings normally have a credit balance. Net income increases the account through a credit during closing; losses and dividends reduce it.
Can a company pay dividends with negative retained earnings?
Corporate and state-law restrictions vary. Solvency tests, loan covenants, and board duties may also apply. Obtain legal and tax advice before declaring a distribution.
Sources reviewed: OpenStax expanded accounting equation and statement of retained earnings guidance. Last reviewed August 15, 2026.
This article provides general educational information and is not accounting, tax, investment, or legal advice.