Article

Managed Accounting, Tax Accounting

QuickBooks, Sage

How To Calculate Retained Earnings? Explained!

Posted on May 2, 2024

By Michele Roletter

May 24, 2024

Retained earnings are essential for a business to manage its annual budget and future growth. They directly correlate to the organic capital a business can use to increase its scope and they are an essential part of corporate finance that every business owner needs to grasp sooner or later. So, how do you calculate retained earnings? And how are they different from profit? In this article, we shall talk about retained earnings in depth starting from what they are, how they can affect your business, and how to calculate them.

What are Retained Earnings?

Retained earnings are the primary source of internal funding for a company. Think of retained earnings similar to a savings account but for a business. The term “retained” stands to signify the fact that these earnings are not the total earnings of a corporation. Retained earnings are merely what the business can retain after paying off the shareholders. Retained earnings are also an accumulative fund, so new earnings get piled on top of the old ones. The business can invest the earnings after accumulating a sufficient amount.

What Affects Retained Earnings?

Beginning period retained earnings, Net Income, and Dividends are the three major modifiers that affect retained earnings. They are also the three values you need to calculate retained earnings for a fiscal year.

  • The Beginning period retained earnings: The retained earnings of the previous fiscal year. Because retained earnings are cumulative, they accumulate on top of your pre-existing savings.
  • Net income: The true income of your business, which means your total revenue minus the production cost, tax, and other related expenses. Any changes to the net income will directly affect your retained earnings. Retained earnings and net income share a positive correlation.
  • Dividends: Dividends refer to the portion of your revenue you pay the shareholders. They share a negative correlation with retained earnings by nature.  The more money you need to pay shareholders, the less you “retain” as earnings.

Want to learn more? Book a meeting with us today!

How to Calculate Retained Earnings

Now that you know about the variables that affect retained earnings, let’s move on to the calculations. Retained earnings are reported in the “stockholders’ equity” section on the company balance sheet. It’s a figure that represents the retained earnings of that particular fiscal year.

You can calculate the retained earnings of a year by subtracting the dividends from the combination of beginning retained earnings and that year’s net income. So, the equation looks like this:

(Beginning Retained Earnings + Net Income) -Dividends = Ending Retained Earnings

Ending retained earnings represents the figure the company retains after paying off its dividends. This money goes toward the growth of the business.

You could manually figure out retained earnings from the company balance sheet. However, once a business grows beyond a certain level, it becomes nearly impossible to keep track of everything without sufficiently powerful accounting software. Most businesses also empower their business finance by using smart analytic tools to keep track of their capital and expenses. These tools make bookkeeping much easier for regular businesses. The advent of Artificial Intelligence has also improved the performance of these finance tools by a significant margin and has created more options for automation.

Why Is It Important to Keep Track of Retained Earnings?

Retained earnings are essential for increasing the operational scope of a company. They can directly affect the direction of a company’s growth and major management decisions. They can also be an acceptable modifier for assessing a company’s condition since the figure essentially represents the historical profits retained by a company.

Retained earnings are essentially a company’s surplus capital. The company can choose to reinvest the money to grow the company or save it for potential disruption in the market. Many businesses will employ technology strategy consultants to keep up with the latest happenings in our techno-centric economy.

Once you calculate retained earnings, here are just a few things you’ll be better poised to invest in:

Invest in Infrastructure

You can invest retained earnings into infrastructure to increase your scope of operations. That can include hiring more manpower or investing in digital marketing or custom software development. Investing in tech-based infrastructure has become the trend in recent years. Other investment avenues also include repairs or production facility upgrades.

Invest in Product Development

You can also invest retained earnings into research to develop more products. A business can explore untapped markets with its surplus capital. For example, a military arms manufacturer can easily join the household appliance market like General Electrics did.

Invest in Strategic Maneuvering

You can also use the surplus capital to complete strategic mergers to buy out your competitors. The money can also go toward paying off outstanding business debts.

Invest in Hiring

Finally, retained earnings can be used to bring in new staff and top talent. More stuff equals more productivity. And that in turn means more profit. The retained money can also help you support your staff in the initial phase of hiring them.

Conclusion

By now, you should understand how to calculate retained earnings. The importance of properly managing the retained earnings should also be quite apparent. It is the single most important source of funding that directly goes towards the overall growth of a business. You can use the latest finance software or even custom tools to keep track of it.

If you’re looking to further enhance your financial strategy and ensure optimal management of your retained earnings, consider reaching out to the accounting experts at KDG. Our team can help you not only calculate and report on your retained earnings but also strategize effectively to maximize your investment and foster growth. Contact KDG today to secure your business’s financial future and drive sustainable growth.

Steve Solt headshot

Michele is an accomplished Accountant, bringing a wealth of knowledge and expertise to her current CPA role at KDG. Experienced in Sage Products, Tax Preparation, GAAP, Financial Accounting and Managerial Accounting. Michele has spent her career overseeing tax preparation and accounting services at a multitude of organizations, even owning her own successful CPA firm.

Want to learn more? Book a meeting with us today!

Recent Posts
KDG logo

Transform Your Managed Accounting with KDG

Elevate your business's financial management with our expert accounting services & transform complex challenges into growth opportunities.

Share this post!

Explore More: Related Insights

  • Article
    Will You Lose Support in 2020?
  • Case Study
    EEACS: Highlighting a Local School’s Innovation
  • Article
    Inflation and the Security of Your Business