Not everything a company earns will stay in the business. Even after calculating net income, a chunk of revenue goes out to shareholders. What you’re left with is retained earnings. This number shows exactly how much money is left to fuel everything from market expansions to daily operations.
In this article, we’re giving you an in-depth guide to statements of retained earnings and how you can prepare one in three steps.
A statement of retained earnings shows your company’s net profits after paying dividends to shareholders. Businesses typically prepare one at the end of an accounting period, whether monthly, quarterly, or annually. A statement of retained earnings answers the question: “How much money have we managed to keep in the business for reinvestment and growth?”
Your retained earnings can be unappropriated—meaning your company hasn’t allocated them to any specific purpose—or they can be appropriated—meaning your business has a plan for them. For example, retained earnings could be earmarked for launching new projects.
💭 Cledara tip: Some businesses don’t regularly create statements of retained earnings but do math on other financial statements. While this can save you time, we don’t recommend it if you want a thorough trail detailing your reinvestment profits.
It’s easy to confuse the statement of retained earnings with net income—but it’s a mistake you want to avoid. There’s a crucial difference.
Net income is the total profit your company earned (gross profit) during a fixed period minus taxes, interests, and cost of goods sold. Retained earnings also subtracts dividends, you pay to shareholders from your net income.
Your business should be regularly preparing a statement of retained earnings because it helps to:
You can think of the statement of retained earnings as a trust-building document as well as a key financial document.
You should use a statement of retained earnings to assess your business’s financial health monthly, quarterly, and yearly. Some other instances when this major financial document is useful include:
Now that you know the why and when of retained earnings, let’s take an in-depth look at how to prepare them.
Any statement of retained earnings should include five core components:
It helps to have other financial statements you can check while preparing your current retained earnings. You’ll find your opening balance on your previous statement (where it’ll be the closing balance), your net income on your income statement, and dividends on your cash flow statement.
Got ‘em? Good. Here’s how to prepare a statement of retained earnings in three steps.
A concise heading will help anyone reading your document immediately realize its purpose and scope. Include three lines at the top of the page with your company’s name, the document type, and the fiscal period.
Here’s how that will look on the statement:
Next, find your previous statement of retained earnings’ ending balance and add it as the opening balance for your current document. If you’re creating a yearly statement of retained earnings, use the one from the previous year, rather than a monthly, or quarterly document version.
For example, let’s say you’re preparing a statement for a business development SaaS called Vertgrowth Solutions.
Checking previous statements, you find your closing was $200,000 last year—so that’s a $200,000 opening balance this year.
Then you look to this year’s performance. Gross income was $100,000, and after subtracting taxes, interests, and cost of goods sold, the net income amounts to $50,000. Payments made to executives and shareholders and mark the dividends up to $10,000.
Make sure to have ‘add’ before net income since it represents money coming into the business and ‘less’ before dividends because of money going out.
All that’s left is to calculate your closing balance and retained earnings with the formula:
That gives us: $200,000 + $50,00 - $10,000 = $240,000.
Here’s what that will look like on your statement:
After you’ve calculated retained earnings, you can go the extra step and calculate the retention ratio. This is a percentage view of the portion of your net income that you retain instead of paying out to shareholders.
To calculate it, use the formula: Retained earnings / Net income.
You’ll sometimes see this as (Net income-Dividends) / Net income; it’s the exact same thing—net income-dividends are retained earnings.
In the example of Vertgrowth, the retention ratio is $40,000 / $50,000 = 80% (or $50,000 - $10,000) / $50,000 = 80%).
Keep in mind that there’s no consensus on how much a retention ratio should be. Rather, you want to measure stability over time. A fluctuating retention ratio year in and year out suggests on-the-fly financial decisions rather than a clear-cut financial plan—which is essential for long-term success.
To ensure you get your numbers right next time you calculate retained earnings, here are three expert-led best practices.
With so many financial records to consult, calculating retained earnings can get confusing fast. Just one wrong number is enough to give you skewed results.
I've found that most businesses forget dividend distributions or fail to reconcile retained earnings with other financial statements. One best practice that I suggest is maintaining a detailed record of all board-approved dividend distributions and reconciling on a monthly basis.
Another way to make sure you have the right numbers on hand includes using CFO dashboard tools or consulting your last CFO report. Both of these options ensure you have some helpful KPIs on hand and give you a broader look at your company’s overall financial health.
Not all companies share the same long-term financial objectives. While early-stage startups focus primarily on growth, mature enterprises typically balance shareholder value between dividends and continued expansion, rather than pursuing pure growth alone. Once you have accumulated retained earnings, it is crucial to allocate them in alignment with your company's lifecycle stage.
At Cledara, we prioritize growth by investing in innovation and acquiring new customers to drive revenue. As a high-growth company backed by institutional investors, our focus remains on scaling rather than generating positive retained earnings at this stage. This approach lays the foundation for long-term success, ensuring we achieve positive retained earnings in the future to reinvest in the business.
To avoid depleting resources for growth and reinvestment, establish a clear dividend policy with your board of directors. For example, outlining the payout ratio and specifying circumstances under which dividends can be reduced can help protect your reinvestment profit.
A retained earnings statement tells you how much you’re reinvesting in your business after you’ve paid your shareholders. It’s the magic number that tells you how much you have on hand to invest in growth and running your daily operations. All you need is your net income, your previous retained earnings, and the formula.
Whatever you do, don’t stop at one statement; make calculating retained earnings a regular habit monthly, or at least quarterly—it’s good financial practice! Plus, your shareholders will thank you for it, and every business wants happy shareholders.
Stephen is Cledara’s in-house Finance Manager who thrives in businesses with fast-paced growth. Stephen’s role is to provide insights to the wider business, he has been heavily involved in cross-functional projects stretching across the introduction of global benefits, financial modelling and KPI reporting procedures. Outside of work, football and American football are his favourite pastimes.
