Retained earnings. Sounds like some complicated tear-inducing accounting vocabulary? Well, it’s not that terrifying once you get a grip of it! Retained earnings are a significant financial detail every business must know (even if you’re a small business).
But what is retained earnings? What is the retained earnings formula? Where can you find it? In this blog, let’s break down everything you need about retained earnings. Ready to find out all the details?
What is a statement of retained earnings?
Also known as earnings surplus, retained earnings are the net profit your business keeps after paying out taxes and expenses. Businesses—large and small—use retained earnings to fund future ventures and investments.
For example, a business with a seasonal product might save its retained earnings to pay for employee salaries and extra costs during off-peak season. It might also use its retained earnings to invest in new technology or equipment!
What are retained earnings used for?
Retained earnings can be used for a variety of reasons, such as:
- Funding your everyday business operations,
- Investing in new equipment, technology or marketing campaigns,
- Saving up for rainy days,
- Making debt repayments,
- Buying other businesses,
- Fund R&D or growth opportunities.
How much should my retained earnings be?
There’s no one-size-fits-all figure we can give you for retained earnings. But there is an ideal ratio you can aim for! Having a 1:1 ratio between your retained earnings and total assets is the golden ratio every business can aim for.
This means your retained earnings have the same value as your total assets. That said, it’s not realistic for most businesses to achieve this, so just get as close as you can!
What’s the difference between retained earnings and revenue?
Revenue is the total earnings your business makes from selling your product/service. It’s also known as your gross sales and has no cost deductions. On the other hand, retained earnings is the money you’re left with after you’ve paid out all expenses and taxes. This is also known as the net income or earnings surplus.
Secondly, the business revenue shows up in an income statement. But retained earnings can be found in your balance sheet under Shareholder’s Equity. Another difference between retained earnings and revenue is that the latter is not time-bound while revenue is only calculated for a specific period.
Are retained earnings an asset?
Retained earnings aren’t exactly assets. Instead, they’re a type of equity and reported within the shareholder’s equity section of your business’s balance sheet. However, retained earnings can be— and often are— used to buy assets like equipment, investments or even inventory.
How to calculate retained earnings
Want to learn how to calculate retained earnings without getting a math sweat? Here is an easy retained earnings formula you can use:
Retained earnings = beginning retained earnings + profit or loss for the period - dividends paid
You can find all three values quite easily by sifting through your financial documents:
- Beginning retained earnings can be found in your most recent balance sheet under Shareholder’s Equity.
- Profit or loss for the period can be found at the bottom of your income statement. It is the total profit you’ve made after subtracting all costs associated with it (or the lack thereof).
- The dividends paid are the amount you’ve paid your shareholders in the current period. If you haven’t paid anything out, you can add 0 to the formula and move on.
Now let’s look at a retained earnings example from the formula we’ve just learned. Imagine you run a thriving artisan bakery known for its organic breads and pastries. After several successful years, you’re now eyeing a second location in a bustling downtown area to expand your customer base.
However, to secure a small business loan for the expansion, your lender needs to see how much retained earnings are available to reinvest in the business.
These are your financial details for the last quarter:
- Beginning retained earnings: $75,000
- Net income: $20,000
- Dividends paid: $5,000
To calculate her retained earnings, Alexis uses the formula:
$75,000 + $20,000 - $5,000 = $90,000
That means Alexis has $90,000 in retained earnings.
The challenge in calculating retained earnings
Tracking retained earnings can feel like going down a maze with blindfolds on. Manual receipt tracking is tedious, prone to human error, and you can overlook critical expenses while you’re at it. Not to mention the time sink of categorizing these expenses and organizing historical data! These challenges can make bookkeeping more of a chore than it needs to be.
That’s where Receiptor AI steps in to revolutionize your workflow…
Prepare expense evidence with Receiptor AI
Receiptor collects receipts and invoices, checks extracted amounts, and organizes the documents for review and supported accounting handoffs. That helps prepare the expense evidence used in your books.
Retained earnings depend on the accounting records, including the opening balance, net income or loss, and dividends. Receipt extraction alone does not calculate or verify that balance. Use your ledger and the appropriate accounting review for the calculation.
Final Thoughts
Retained earnings are a critical financial aspect every business must look into. Not only is it important to understand your financial health, but it can also sway investors and lenders’ decisions to invest in your business.
Retained earnings appear within equity on the balance sheet. Use the accounting records to calculate the balance and retain the supporting evidence for the transactions that feed those records.
