How to Calculate Retained Earnings (Formula and Examples)

 Retained earnings are a running tally of how much profit your company has managed to keep since its inception. They rise whenever your company makes a profit and fall whenever you distribute some of those profits as dividends.

We'll go over how to calculate retained earnings correctly and show you some examples of retained earnings in action.

How to Determine Retained Earnings

The retained earnings formula is fairly simple:

Retained Earnings = Current Retained Earnings + Profit/Loss – Dividends

When your accounting software generates your company's balance sheet, statement of retained earnings, and other financial statements, it will handle this calculation for you.

If you are calculating retained earnings manually, you must first determine the following three variables before plugging them into the equation above:

• Your current or initial retained earnings, which are simply whatever your retained earnings balance was the last time you calculated it. (For example, if you create a balance sheet monthly, you'll use the previous month's retained earnings.)
• Your net profit/loss, which will most likely be derived from the income statement for this accounting period. If you generate those on a monthly basis, for example, use the current month's net income or loss. (Learn how to calculate net income here.)
• Any dividends you paid out during this time period, which are company profits that you and the other shareholders chose to take out of the company. When a cash dividend is declared, each shareholder receives a cash payment. The greater a shareholder's share of the dividend, the greater their share of the dividend.

An example of calculating retained earnings

Assume your company began operations on January 1, 2020. Because you have no earnings to retain, your retained earnings account will be $0 on January 1, 2020.

Let's say you earn $1,000 in net income (from your income statement) in January and don't pay any dividends.

That means your company's retained earnings will be $1,000 on February 1:

Current retained earnings minus net income minus dividends equals retained earnings.

$1,000 = $0 + $1,000 - $1,000

This makes sense: you made $1,000 in profits and kept them all.

What is the impact of a cash dividend on retained earnings?

Let's say your company does exceptionally well in February and you make a $10,000 profit that month. You're doing so well that at the end of February, you decide to distribute $2,000 of your profits to your shareholders in the form of cash dividends (you, your mom and your aunt Karen). Also, keep in mind that the initial balance for retained earnings will be $1,000.

That means your retained earnings will be $9,000 on March 1:

Current retained earnings minus net income minus dividends equals retained earnings.

$1,000 - $10,000 - $2,000 = $9,000

How to figure out the impact of a stock dividend on retained earnings

A stock dividend is issued when a company wants to reward its shareholders with a dividend without giving away any cash. This is simply a dividend payment made in the form of company stock rather than cash.

Calculating retained earnings after a stock dividend requires a few extra steps to determine the exact amount of dividends to distribute.

First, determine the fair market value (FMV) of the shares you intend to distribute. Companies will also typically pay out a percentage of their total stock as a dividend (for example, a 5% stock dividend means you're giving away 5% of the company's equity). So you must determine the exact number of shares.

In equation form, the retained earnings formula in a stock dividend is:

Retained earnings = current retained earnings + net income - (number of shares x FMV of each share)

A stock dividend calculation example

Let's say your business is still booming in March and you make another $10,000 in profit. Because you intend to keep that money for reinvestment in the business, you forego a cash dividend in favour of a 5% stock dividend.

Assume your company has 10,000 outstanding shares of common stock and you determine the fair market value of each share to be $10. That is, you would issue 500 dividend shares, each of which would reduce retained earnings by $10:

Retained earnings = current retained earnings + net income - (number of shares x FMV of each share)

$14000 = $9,000 + $10,000 - (500 x $10)

This means that the company's retained earnings on April 1 would be $14,000.

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