Retained earnings are the profits a business has kept over its life rather than paid out to its owners. The formula is beginning retained earnings plus net income (or minus a net loss) minus dividends, and the result sits in the equity section of the balance sheet.
CFI describes retained earnings as the accumulated portion of profits that wasn't distributed as dividends but held back for reinvestment. Xero's small business glossary puts it more simply: the share of net profit kept in the business rather than paid to owners. Either way, it's a running total, built up period after period since the business started.
The retained earnings formula
CFI's formula is: retained earnings = beginning retained earnings + net income (or loss) - cash dividends - stock dividends. The ending balance for one period becomes the beginning balance for the next, which is what makes it cumulative. A statement of retained earnings is simply the summary of those changes over a period.
- Take last period's ending retained earnings as this period's beginning balance.
- Add net income, or subtract a net loss.
- Subtract cash and stock dividends, or owner draws.
- The result is your ending balance, which goes on the balance sheet.
Retained earnings are the link between your two main reports. Net income comes from the income statement, and CFI points out that it flows into equity on the balance sheet through this number. If you've never been clear on how those reports relate, my guide to profit and loss vs balance sheet covers it.
Two worked examples
Here are the two examples from the sources, side by side. They're the sources' US dollar figures, as of October 2026, and the formula works the same in whatever currency you use.
| Item | CFI example (dividends found backwards) | Xero example |
|---|---|---|
| Beginning retained earnings | $77,232 | $50,000 |
| Net income | $5,297 | $30,000 |
| Dividends paid | $3,797 (derived) | $10,000 |
| Ending retained earnings | $78,732 | $70,000 |
Xero's is the straightforward version: a business starts the year with $50,000 of retained earnings, earns $30,000 of net income and pays $10,000 in dividends, so it ends the year on $50,000 + $30,000 - $10,000 = $70,000.
The catch: you can work backwards to find the dividends
CFI's example is the clever one. If you know the opening and closing retained earnings and the net income, you can work out how much was paid out, even when nobody tells you. Rearranged, the formula is: beginning retained earnings - ending retained earnings + net income = dividends.
With CFI's figures, that's $77,232 - $78,732 + $5,297 = $3,797 of dividends. Check it the normal way round: $77,232 + $5,297 - $3,797 = $78,732. It matches. That's a handy test when you're reading someone else's accounts and want to know how much profit the owners took out.
Revenue vs net income vs retained earnings
These three get muddled all the time. Xero separates them like this:
| Measure | What it means (Xero) | Time frame |
|---|---|---|
| Revenue | Total income from sales, before any expenses | One period |
| Net income | What's left after expenses and taxes | One period |
| Retained earnings | What remains after also subtracting dividends or owner draws | Every period since the start, added together |
So a business can have a great year of revenue, a modest net income and still a small retained earnings figure if the owners took most of the profit out. If you want to see how much of your revenue becomes profit, here's how to calculate net profit margin.
Cash dividends vs stock dividends
CFI explains that the two types hit the balance sheet differently. A cash dividend is an outflow: it reduces the cash account and shrinks the balance sheet. A stock dividend needs no cash. Instead, it moves part of retained earnings into common stock and additional paid-in capital, so the balance sheet stays the same size, but the value of each share falls.
Can retained earnings be negative?
Yes. CFI says it happens when a period's net loss is bigger than the opening balance, or when large dividends exceed it. Anything that affects net income affects retained earnings too: sales revenue, cost of goods sold, depreciation and other operating expenses, plus non-cash items such as write-downs, impairments and stock-based compensation.
Want AI doing the heavy lifting in your marketing?
I build the systems that handle the boring 80 percent, so you get your week back. Done properly, with the human kept in.
Xero adds the small business view. Owner draws in sole proprietorships and partnerships reduce the balance, as do prior-period adjustments, and over time the age of the business, seasonality and dividend policy all play a part. Low or negative retained earnings can signal trouble to lenders, while a strong balance improves your borrowing capacity.
What businesses do with retained earnings
CFI says they're normally used for working capital, capital expenditure or paying down debt. Xero adds growth and emergency reserves, all funded without going to outside investors. CFI also makes a sharp point about larger companies: if a business can't earn a better return on its retained earnings than its cost of capital, it will often hand them back as dividends or buy back shares instead.
Before you report, the books need to agree, as trial balance shows.
My verdict
Retained earnings are the profit you chose to keep working in the business. A number that grows year after year tells a lender you're profitable and you're reinvesting, which is exactly what they want to see. A shrinking one isn't always bad, as it may just mean the owners paid themselves, but you should always know which one it's telling you. And if a figure looks off, use CFI's backwards formula to see what was paid out. For the profit side of the picture, my guide to gross vs net profit is the place to start.
For the rest of the series, see the Creator Pay Rates: What YouTube, TikTok, Instagram, Facebook and Snapchat Really Pay (75 Answers).
Frequently asked questions
What is the formula for retained earnings?
Beginning retained earnings plus net income (or minus a net loss) minus dividends. CFI splits dividends into cash dividends and stock dividends.
Where do retained earnings appear?
In the equity section of the balance sheet. CFI calls it the shareholders' equity section; Xero calls it owner's equity.
Are retained earnings the same as net income?
No. Net income is one period's profit after expenses and taxes. Retained earnings add up what's left of every period's profit after dividends or owner draws.
Can retained earnings be negative?
Yes, when a net loss is bigger than the opening balance or when large dividends exceed it. Xero says low or negative retained earnings can signal trouble to lenders.
How do you calculate dividends from retained earnings?
Beginning retained earnings minus ending retained earnings plus net income. In CFI's example that gives $3,797 of dividends.
