Finance⏱ 5 min read
What Are Retained Earnings and How Do You Calculate Them?
Retained earnings appear on every company balance sheet but are frequently misunderstood — even by business owners. Here's what they actually represent and the exact calculation.
Retained earnings are the cumulative profits a company has kept since it started — after paying all dividends to shareholders. They represent the company's internal funding source and tell you how much wealth the business has generated and reinvested over its lifetime.
The Formula
Retained Earnings (end of period) =
Retained Earnings (start of period)
+ Net Income for the period
- Dividends paid in the period
First year of trading:
Starting retained earnings: £0
Net profit year 1: £45,000
Dividends paid: £15,000
Ending retained earnings: £0 + £45,000 - £15,000 = £30,000
Year 2:
Starting retained earnings: £30,000
Net profit year 2: £62,000
Dividends paid: £20,000
Ending retained earnings: £30,000 + £62,000 - £20,000 = £72,000
Where Retained Earnings Appear on the Balance Sheet
Balance Sheet (simplified):
ASSETS LIABILITIES + EQUITY
Cash: £80,000 Trade payables: £25,000
Stock: £30,000 Bank loan: £50,000
Equipment: £60,000 Share capital: £20,000
Retained earnings: £75,000
Total: £170,000 Total: £170,000
Retained earnings sit in the equity section.
They are NOT cash — they represent the total accumulated
profits reinvested into the business (as equipment, stock,
cash, or used to repay debt).
A company with £200,000 retained earnings may have only
£5,000 in cash if it has been investing heavily.
Retained Earnings vs Cash: The Critical Distinction
Many business owners confuse retained earnings with available cash. They are completely different:
- Retained earnings are an accounting figure on the balance sheet — the sum of all past profits kept in the business
- Cash is a physical asset — what's in the bank account
- A profitable business can run out of cash (overtrading); a loss-making business can hold significant cash (burning reserves)
When Retained Earnings Go Negative
Accumulated losses (negative retained earnings) = "Accumulated deficit"
Starting RE: £50,000
Year 1 loss: -£80,000
Dividends: £0
Ending RE: £50,000 - £80,000 = -£30,000
This is an accumulated deficit — the company has lost more
than it ever earned. Common in early-stage businesses
funded by external investment.
A company cannot pay dividends if it would create or worsen
an accumulated deficit (UK Companies Act 2006).
Using Retained Earnings for Director Salary Decisions
For small owner-managed companies, retained earnings indicate how much profit has built up inside the company. Directors often draw this down as dividends (taxed at dividend rates) rather than salary (taxed as income + NI). The retained earnings balance is the maximum you can theoretically distribute — though in practice it's limited by available cash.