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How to prepare a retained earnings statement
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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.
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:
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:
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.
FAQs
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.
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.
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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