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Table of contents

A statement of retained earnings shows how a company reinvests profits back into the business or distributes them as dividends to shareholders over a specific time period. 

Many people focus on the income statement or balance sheet to assess financial health, but the statement of retained earnings is just as important because it shows how a business manages profits. Understanding the statement of retained earnings is crucial for investors and owners.

What is a statement of retained earnings?

A statement of retained earnings—or retained earnings statement—tracks the net profit a company reinvests to grow its business, uses to pay down liabilities, or reserves for future use. It’s vital for understanding a company's financial health and long-term growth strategy.

A retained earnings statement illustrates how much a company devotes to reinvestment versus what it returns to shareholders as dividend payments. The statement also links the income statement and balance sheet, offering a view of how profits flow through the company.

FAQ
Why is a statement of retained earnings important?
By analyzing a statement of retained earnings, stakeholders can assess your company's ability to sustain operations and invest in future opportunitiess. It helps you make informed decisions about your business's resource allocation and future plans, and it also allows investors to evaluate whether you’re prioritizing growth or shareholder returns.

Elements of a retained earnings statement

To prepare a proper statement of retained earnings, you need to understand its components and apply the correct retained earnings formula to ensure accuracy. Below are the elements, along with examples and corresponding formulas, as applicable:

Element Definition Formula
Beginning retained earnings The retained earnings balance from the company's previous accounting period, carried over to the new period. -
Net income or net loss Net income (or net loss) is derived from the income statement. Net income increases retained earnings, while a net loss decreases it. Net Income = Revenue - Expenses
Dividend payments Cash or stock dividends paid to shareholders, reducing retained earnings. Retained Earnings = Beginning Retained Earnings - Dividends
Adjustments Corrections from prior periods or changes in accounting methods that impact the retained earnings balance. Adjusted Retained Earnings = Retained Earnings + Adjustments
Ending retained earnings The final retained earnings figure, which appears on the balance sheet under shareholders' equity. Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends + Adjustments

Step by step: How to prepare a statement of retained earnings

Here’s a walk through the process of preparing a returned earnings statement for your business, from beginning retained earnings to the final balance.

1. Start with beginning retained earnings

Begin with the retained earnings balance from the previous period. This balance represents the company's accumulated earnings from past years that have been reinvested in the business.

Example

If the retained earnings at the start of the year are $50,000, this amount will be used as the starting point for the current period’s calculations.

2. Add net income (or subtract net loss) from the income statement

Next, determine the net income or net loss for the period. This comes from your income statement and reflects the profitability of the company over the accounting period.

  • Net income: Increases retained earnings
  • Net loss: Decreases retained earnings

Formula

Net Income (or Loss) = Revenue - Expenses

Example

If your income statement shows a net income of $20,000 for the period, you’d add this to your beginning retained earnings. If your company had a net loss of $5,000, you’d subtract it.

3. Subtract dividend payments to shareholders

Dividends are payments made to shareholders, either in cash or stock, as a portion of the company’s earnings. These reduce the retained earnings balance because you distribute them to shareholders rather than keeping them within your company.

Formula

Retained Earnings = Beginning Retained Earnings - Dividends

Example

If your company declared and paid out $10,000 in dividends, you’d subtract this amount from your retained earnings balance after adding net income.

4. Include adjustments for prior periods

In some cases, you may have to make changes because of errors in previous periods or shifts in accounting methods. You typically record these as prior period adjustments and must include them in the current period’s statement to ensure accuracy.

Example

If an accounting error from the previous year resulted in an overstatement of $2,000 in expenses, an adjustment would be made to increase the retained earnings by $2,000.

5. Calculate ending retained earnings to match your balance sheet

With all your components in, calculate the ending retained earnings balance for the current period. This is your company’s total accumulated earnings retained within the business. It should line up with the retained earnings figure listed under shareholders’ equity on your balance sheet.

Formula

Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends + Adjustments

Example

If you start with a beginning retained earnings of $50,000, add net income of $20,000, subtract dividends of $10,000, and include a $2,000 adjustment, the ending retained earnings would be:

$50,000 + $20,000 - $10,000 + $2,000 = $62,000

Statement of retained earnings example

Here’s a simplified version of a retained earnings statement based on the steps above:

Description Amount
Beginning Retained Earnings $50,000
Add: Net Income $20,000
Subtract: Dividends ($10,000)
Add: Adjustment for Prior Period $2,000
Ending Retained Earnings $62,000

Common mistakes when preparing a retained earnings statement

It's easy to introduce errors and get your financial reporting wrong when you prepare a statement of retained earnings. Here are some pitfalls to watch out for:

  • Forgetting to include prior period adjustments: You must include corrections or changes in accounting methods from previous periods to ensure accuracy
  • Misclassifying dividends: You should subtract dividends from retained earnings, but sometimes you might mistakenly add or overlook them and skew your final figure
  • Not updating with net income or loss: If you don’t properly add net income to beginning retained earnings or subtract net loss, your statement won’t reflect your true earnings
  • Omitting the beginning balance: Failing to correctly carry over the previous period’s retained earnings balance can lead to miscalculating the final figure
  • Confusing cash dividends and stock dividends: Both types affect retained earnings, but make sure you record them accurately by type and amount

Statement of retained earnings vs. other financial statements

Understanding these distinctions grants you a more nuanced view of your company’s financial health and operations. Here are the most common comparisons:

Balance sheet vs. statement of retained earnings

The balance sheet provides a snapshot of a company’s financial position at a given moment, including total assets, liabilities, and equity. While the balance sheet shows the company's overall equity, the retained earnings statement concentrates specifically on the portion of equity that comes from reinvested profits, excluding any external funding or investments.

Income statement vs. statement of retained earnings

The income statement tracks performance over a specific period, summarizing revenues, expenses, and profits or losses. In contrast, the statement of retained earnings shows how those profits—or losses—are allocated, reflecting how much is reinvested into the company or distributed as dividends.

Cash flow statement vs. statement of retained earnings

The cash flow statement tracks cash movement in and out of your business, including operating, investing, and financing activities. Unlike the cash flow statement, which focuses on liquidity, the retained earnings statement is accrual-based, showing profits and losses whether or not they resulted in cash flow.

Statement of shareholders' equity vs. statement of retained earnings

The statement of shareholders’ equity provides a look at changes in the company’s equity accounts, including common stock issuance, retained earnings, and other comprehensive income. While the retained earnings statement is a subset of this larger statement, it specifically tracks the changes in accumulated profits, separate from stock issuance or other equity-related activities.

Automate your retained earnings statement

The statement of retained earnings helps you understand how a company manages profits over time. Whether you’re a business owner or investor, preparing and analyzing this statement ensures the retained earnings account is up to date, promoting transparency and informed decision-making.

Moving forward, it’s important to integrate the retained earnings statement with other key financial documents, such as the balance sheet and income statement, to gauge your business’s financial health. Automating this process can save time, especially as your finances grow more complicated.

Ramp streamlines your financial reporting and integrates with your existing tools, making it easier to manage retained earnings, track expenses, and ensure your financial statements are accurate and current. This means you can focus on strategic growth and worry less about manual accounting tasks.

Learn more about how Ramp’s accounting automation software can help.

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Head of Accounting Partner Channel, Ramp
Brad Gustafson leads the Accounting Partnerships Channel at Ramp. He has spent the past decade advising and consulting thousands of accounting firms across the United States, including managing Top 100 accounting firm partnerships as an Enterprise Account Director at Xero. He is motivated to help build a community of accountants around Ramp who are passionate about new technologies and the opportunities they provide the accounting profession.
Ramp is dedicated to helping businesses of all sizes make informed decisions. We adhere to strict editorial guidelines to ensure that our content meets and maintains our high standards.

FAQs

What is the difference between retained earnings statement and profit and loss statement?

Retained earnings are profits that are left over after dividends have been paid out to shareholders. The profit and loss statement keeps track of revenue and expenses to come up with a taxable net income number, like the income statement. The P&L statement is also not a recognized official financial report according to the FASB.

What is the difference between retained earnings and paid-in capital?

Retained earnings are often called earned capital, so the confusion around these two terms is understandable. Paid-in capital is the amount of money invested in a company during the reporting period. Retained earnings are what’s left over after all financial obligations have been met, including dividend payments if the company issues them.

What is on a statement of retained earnings?

The statement of retained earnings is a mathematical calculation. It starts with retained earnings at the beginning of the period, adds in net income, and subtracts dividends to come up with retained earnings for the current period. There may also be a line for adjustments if the numbers from the previous period were incorrect.

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