Statement of Retained Earnings: Formula, Examples & Step-by-Step Guide

If you run a business near Downtown LA or out in the Valley, you have probably heard your bookkeeper mention retained earnings. Maybe your bank asked for it before approving a loan. Maybe your accountant brought it up at tax time and you nodded along without really knowing what it meant.

A statement of retained earnings sounds complicated. It is not. Once you see the formula and walk through one real example, it clicks. This guide breaks it down in plain English, with the exact steps a CPA follows when preparing one for a client here in Los Angeles.

What Is a Statement of Retained Earnings?

A statement of retained earnings shows how much profit your business kept over a period of time, instead of paying it out to owners or shareholders. It starts with last year’s balance, adds this year’s profit, subtracts any money paid out, and lands on a new ending balance.

Think of it as a running total. Every year your business either adds to that total or takes away from it. The statement just shows the math behind that change.

Small businesses do not always prepare this as its own document. Many fold it into the balance sheet instead. But once your business starts working with investors, applies for a business loan, or brings on a new partner, lenders and investors usually want to see it on its own.

What Is the Formula for Retained Earnings?

The formula is short:

Ending Retained Earnings = Beginning Retained Earnings + Net Income (or minus Net Loss) − Dividends or Distributions

That is the whole statement in one line. Everything else in this guide is just explaining each piece of that formula and showing you how to apply it.

Is Retained Earnings an Asset?

No. Retained earnings is not an asset. It sits under shareholders’ equity on the balance sheet, right next to common stock and paid in capital.

People confuse this because retained earnings often gets spent on assets. A company might use retained earnings to buy equipment or open a second location. But the account itself represents accumulated profit, not the cash or property that profit was used to buy.

Is Retained Earnings Equity?

Yes. Retained earnings is part of shareholders’ equity, or owner’s equity if you run a sole proprietorship or partnership. It reflects the owners’ claim on the business, built up from profit rather than from money they invested directly.

This matters because it changes how the number behaves. Assets and equity are not interchangeable, and a business with strong retained earnings does not automatically have strong cash reserves. Those are two different questions.

Does Retained Earnings Have a Debit or Credit Balance?

Retained earnings normally carries a credit balance. Profit increases it with a credit entry. A net loss or a dividend payment decreases it with a debit entry.

If your retained earnings account shows a debit balance overall, that usually means your business has lost more money over time than it has earned. Accountants call this an accumulated deficit, and we will cover what causes it later in this guide.

The Statement of Retained Earnings Formula, Explained Line by Line

Let’s slow down and look at each part of the formula separately.

Beginning retained earnings is simply last period’s ending balance. You pull this straight from last year’s balance sheet or last period’s statement.

Net income or net loss comes from your income statement. If your business made money this period, you add it. If you lost money, you subtract it.

Dividends or distributions are payments made to owners or shareholders. S-corporations and LLCs often call these distributions instead of dividends, but the effect on the formula is the same. Either way, this reduces retained earnings.

Add those three pieces together and you get your ending balance for the period.

Retention Ratio Formula and What It Actually Tells You

The retention ratio shows what percentage of profit your business kept, instead of paying out.

Retention Ratio = (Net Income − Dividends) ÷ Net Income

A service business in Culver City that reinvests almost everything back into staff and equipment might show a retention ratio close to 90 percent. A mature company that pays regular dividends might sit closer to 40 or 50 percent.

Neither number is automatically good or bad. It depends on your goals, your industry, and how much growth capital your business needs right now.

How to Prepare a Statement of Retained Earnings

Preparing this statement takes five steps. Once you have the right numbers in front of you, it takes ten minutes.

• Find your beginning retained earnings balance from last period’s balance sheet
• Add net income for the current period, or subtract a net loss
• Subtract any dividends or owner distributions paid during the period
• Apply any prior period adjustments, such as corrections to past errors
• Calculate the ending balance, which becomes next period’s starting point

Let’s walk through this with a real example, so the steps make sense in context.

Step 1: Find Beginning Retained Earnings

Pull last year’s ending retained earnings balance from the balance sheet. This becomes your starting point.

Step 2: Add Net Income or Subtract Net Loss

Grab the net income figure from your income statement for the same period. If expenses were higher than revenue, you will subtract a loss instead.

Step 3: Subtract Dividends Paid

List any dividends or distributions paid to owners during the period. If you paid nothing out, this line is zero.

Step 4: Apply Prior Period Adjustments

Sometimes a prior year’s financials need correcting, maybe due to a bookkeeping error or a change in accounting method. These adjustments get applied here, before you calculate the final number.

Step 5: Calculate Ending Retained Earnings

Add and subtract everything above, and you land on your ending retained earnings balance. This number carries forward as next period’s beginning balance.

Statement of Retained Earnings Example

Let’s put real numbers on this. Say a small marketing agency based near the Arts District in Downtown LA had these figures for the year.

Sunset Creative Group Statement of Retained Earnings For the Year Ended December 31

Beginning retained earnings: $180,000 Add: Net income for the year: $95,000 Less: Distributions paid to owners: $40,000 Ending retained earnings: $235,000

The math is simple. $180,000 plus $95,000 minus $40,000 equals $235,000. That $235,000 becomes next year’s starting balance.

Sample Calculation for a Different Scenario

Now imagine that same agency had a rough year instead. Revenue dropped, and the company posted a net loss of $20,000, while still paying out $10,000 in distributions.

Beginning retained earnings: $235,000 Less: Net loss for the year: $20,000 Less: Distributions paid to owners: $10,000 Ending retained earnings: $205,000

Even with a loss, the business still had a positive ending balance, because it had built up a healthy cushion in prior years. This is exactly why lenders like to see a few years of history, not just one snapshot.

Free Template You Can Use

Most small businesses do not need fancy software for this. A simple spreadsheet with four rows, beginning balance, net income or loss, dividends, and ending balance, covers it. If your bookkeeper uses QuickBooks or Xero, this report often generates automatically once your income statement and balance sheet are set up correctly.

How Public Companies Report It?

Public companies report retained earnings inside a broader statement of stockholders’ equity, filed with the Securities and Exchange Commission as part of their 10-K or 10-Q. You can find real examples on the SEC’s EDGAR database if you want to see how large corporations format this. Small businesses rarely need that level of formality, but the underlying math is identical.

Can the Income Statement and Retained Earnings Statement Be Combined?

Yes, and many small businesses do exactly this. Instead of a standalone statement, the retained earnings section gets added to the bottom of the income statement or folded directly into the equity section of the balance sheet.

Larger companies and anyone preparing statements for outside investors usually keep them separate. It makes the retained earnings trend easier to see across multiple years.

How to Analyze a Statement of Retained Earnings

Once you have the numbers, what do they actually tell you?

Rising retained earnings, year after year, usually points to consistent profitability and a business that is reinvesting in itself. That is a good sign for a bank loan application or an SBA loan through the Small Business Administration.

Investors and lenders also compare retained earnings against total equity and total debt. A business with strong retained earnings and manageable debt tends to look more stable on paper, since it has proven it can fund growth from profit rather than borrowing.

What Affects Retained Earnings

A handful of factors move this number every period.

• Net profit or net loss from operations
• Dividend or distribution payments to owners
• Accounting adjustments and corrections from prior periods
• Stock buybacks, in businesses that repurchase shares
• Changes in accounting method that require restating prior figures

Most small businesses only deal with the first two. The rest apply more often to larger or publicly traded companies.

Can Retained Earnings Be Negative?

Yes. A negative balance, often called an accumulated deficit, means a business has paid out or lost more than it has earned over its lifetime.

Common Causes

A few things typically cause this. Years of losses in a row is the most common reason. Startups in their early years almost always show negative retained earnings, since they spend heavily before turning a profit.

Paying large distributions during a slow year can also push the balance negative, especially for S-corporations trying to help owners cover personal tax bills.

How Businesses Recover?

Recovery usually comes down to consistent profitability over several periods. There is no shortcut. A business that returns to steady net income will slowly rebuild its retained earnings balance, one period at a time.

If your business shows a persistent deficit, that is usually the point where a CPA should review your pricing, overhead, and distribution policy together, rather than looking at any one number in isolation.

Where Does the Statement of Retained Earnings Appear?

It connects the income statement to the balance sheet. Net income flows in from the income statement, and the ending balance flows out to the equity section of the balance sheet. For that reason, accountants sometimes call it the bridge between the two.

Statement of Retained Earnings vs Other Financial Statements

It helps to see how this statement compares to the other three core financial statements.

Statement of Retained Earnings vs Balance Sheet

The balance sheet shows a snapshot on one specific day. The retained earnings statement shows the story of how that one line item changed over time.

Statement of Retained Earnings vs Income Statement

The income statement shows revenue and expenses for a period. Net income from that statement becomes an input into the retained earnings calculation, not the other way around.

Statement of Retained Earnings vs Cash Flow Statement

Cash flow tracks actual cash moving in and out of the business. Retained earnings tracks accounting profit, which is not the same thing. A business can show rising retained earnings while still struggling with cash flow, if customers are slow to pay.

Statement of Retained Earnings vs Statement of Shareholders’ Equity

The statement of shareholders’ equity is broader. It includes retained earnings, but also common stock, paid in capital, and treasury stock. Retained earnings is one piece of that larger picture.

GAAP Guidelines for a Statement of Retained Earnings

Under generally accepted accounting principles, set by the Financial Accounting Standards Board, retained earnings must reflect accumulated net income less dividends declared, adjusted for any prior period corrections. FASB requires that adjustments to prior periods be clearly disclosed, rather than quietly folded into the current year’s number. This keeps financial statements consistent from one year to the next, so lenders and investors can trust the trend they see. Including these review steps in your accounting checklist helps ensure retained earnings are reported accurately and that your financial statements remain compliant with GAAP.

Common Statement of Retained Earnings Mistakes

A few errors show up again and again, even among businesses with decent bookkeeping.

• Forgetting to include dividend or distribution payments
• Using total revenue instead of net income in the formula
• Starting with the wrong opening balance, often from an outdated balance sheet
• Mixing up retained earnings with cash on hand
• Skipping prior period adjustments after a bookkeeping correction

Any one of these throws off the ending balance, which then carries the error into next year’s statement too.

Do Small Businesses Need This Statement?

Not always, but it helps more often than owners expect. If you plan to apply for a loan, bring on an investor, or sell the business someday, this statement becomes part of the paperwork almost every time. Even if nobody asks for it this year, keeping it updated saves time later.

CPA Tips: When to Reinvest, Pay Distributions, or Call a CPA

When to Reinvest Earnings

If your business is growing and needs cash for hiring, equipment, or a second location, reinvesting retained earnings usually makes more sense than borrowing at today’s interest rates. This is common among businesses we work with along Wilshire Boulevard and in the South Bay, where commercial rent and staffing costs climb every year.

When to Pay Distributions

If your business has a healthy cash cushion and stable profit, paying out distributions rewards owners without starving the business of working capital. The right amount depends on your cash flow forecast, not just your retained earnings balance.

California Considerations for S-Corps and Distributions

California adds a layer most other states do not. S-corporations here still pay the state’s 1.5 percent franchise tax on net income, on top of federal rules. The California Franchise Tax Board also expects distributions to match ownership percentages, unless payroll has been properly run through reasonable shareholder wages first. Getting this wrong is one of the most common issues we see with new S-corp filings out of the Los Angeles County Registrar Recorder’s office.

When to Consult a CPA in Los Angeles

If your retained earnings balance has gone negative for more than one year, or if you are unsure whether a payment should count as a distribution or a loan repayment, it is time to sit down with a CPA. A short review, often less than an hour, can prevent a much bigger tax problem down the road.

Need Help Preparing a Statement of Retained Earnings?

Our Chaudhry CPA team works with small businesses across Los Angeles, from Downtown to the San Fernando Valley, on exactly this kind of financial statement work. If you want a second set of eyes on your numbers before tax season or your next loan application, reach out for a consultation. We will walk through your specific numbers together, not a generic template.