Retained Earnings Formula
The retained earnings formula calculates the cumulative amount of profits or losses a company retains, after paying out dividends to its shareholders. The formula is:
Retained Earnings (End of Period) = Retained Earnings (Beginning of Period) + Net Income (or Loss) − Dividends Paid
Here’s a breakdown of the components:
- Retained Earnings (Beginning of Period): This is the amount of retained earnings that the company has at the start of the accounting period. For a new company, this value would typically start at $0.
- Net Income (or Loss): This represents the profits or losses the company earned during the accounting period. If the company had more expenses than revenue, this would be a net loss.
- Dividends Paid : This represents the total dividends (both cash and stock dividends) the company distributed to its shareholders during the accounting period. If no dividends were paid, then this value would be $0.
By using the formula, a company can determine how much of its profits (after paying out dividends) it has retained, which can then be reinvested into the company or held as reserves for future use.
Example of the Retained Earnings Formula
Let’s illustrate the retained earnings formula with a new hypothetical scenario involving a company called “BlueWave Technologies.”
BlueWave Technologies
2019:
- Retained Earnings (Beginning of 2019): BlueWave is an established company and starts 2019 with retained earnings of $500,000.
- Net Income (2019): $350,000
- Dividends Paid (2019): $200,000
Using the formula:
Retained Earnings (End of 2019) = Beginning Retained Earnings + Net Income − Dividends
Retained Earnings (End of 2019) = $500,000 + $350,000 – $200,000
Retained Earnings (End of 2019) = $650,000
At the end of 2019, BlueWave Technologies has $650,000 in retained earnings.
2020:
- Retained Earnings (Beginning of 2020): $650,000 (This is carried over from the end of 2019.)
- Net Income (2020): $400,000
- Dividends Paid (2020): $250,000
Using the formula:
Retained Earnings (End of 2020) = Beginning Retained Earnings + Net Income − Dividends
Retained Earnings (End of 2020) = $650,000 + $400,000 – $250,000
Retained Earnings (End of 2020) = $800,000
At the end of 2020, BlueWave Technologies has $800,000 in retained earnings.
In this scenario, BlueWave Technologies consistently earned profits over the two-year period. After accounting for dividends distributed to shareholders each year, we can see the company’s accumulated retained earnings increase annually. This showcases how the retained earnings formula helps businesses track the amount of profits retained within the company over time.
