Retained earnings is the cumulative profit a business has kept rather than distributed to owners as dividends. It accumulates from the first day of trading, growing with each profitable period and shrinking with losses and dividends. It sits in the equity section of the balance sheet, not among the assets.
FORMULA
Ending Retained Earnings = Beginning Retained Earnings + Net Income − Dividends
Losses simply enter as a negative net income, reducing the balance. Every figure in the formula comes from a different statement: the beginning balance from last period's balance sheet, net income from the income statement, and dividends from the statement of changes in equity or the cash flow statement.
EXAMPLE
A business opens the year with $340,000 in retained earnings, earns $86,000 in net income, and pays $25,000 in dividends.
$340,000 + $86,000 − $25,000 = $401,000 ending retained earnings.
To find retained earnings when it is not stated directly, rearrange the accounting equation: total assets minus total liabilities gives total equity, and retained earnings is total equity less contributed capital such as share capital and additional paid-in capital.
The statement of retained earnings is a short financial statement showing how the balance moved across a period. It bridges the income statement and the balance sheet, explaining why equity changed.
EXAMPLE
Statement of Retained Earnings, year ended 31 December
Retained earnings, 1 January: $340,000
Add: net income for the year: $86,000
Less: dividends declared: ($25,000)
Retained earnings, 31 December: $401,000
Smaller companies often present this as a few lines within a broader statement of changes in equity rather than as a standalone statement. The content is identical; only the presentation differs.
Retained earnings sits in the shareholders' equity section, typically below share capital and additional paid-in capital, and it is usually the last line before total equity.
The distinction that matters is between contributed and earned capital. Share capital is money owners put in. Retained earnings is profit the business generated itself and kept. Both are equity, but they arrive by completely different routes.
The balance carries forward permanently. Unlike revenue and expense accounts, which reset to zero at year end, retained earnings is a permanent account: closing entries move the year's net income into it, which is precisely how the balance grows.
No. Retained earnings is an equity account, not an asset. This is one of the most common misunderstandings in accounting, and it comes from assuming retained earnings is a pot of money.
It is not cash. Retained earnings records that profits were kept in the business; it says nothing about what form those profits now take. The money may have been spent on inventory, equipment, debt repayment, or hiring. A business can hold $401,000 in retained earnings and $12,000 in the bank at the same time with nothing wrong.
If retained earnings were cash, it would appear under current assets. It appears under equity because it represents a claim by owners on the business's net assets, not a specific resource the business holds.
Retained earnings normally carries a credit balance, because equity accounts increase with a credit. Applying that:
A negative balance, called an accumulated deficit, means cumulative losses and dividends have exceeded cumulative profits since the business began. It appears in the equity section as a negative figure.
It is not automatically a distress signal. Early-stage companies that have raised capital and spent it pursuing growth routinely carry large accumulated deficits while remaining well funded, because share capital and the deficit are separate lines. What matters is the trend alongside cash position, not the sign on its own.
It becomes a genuine concern when an established, previously profitable business slides into deficit, which indicates sustained losses rather than deliberate investment.
