What are retained earnings?
Learn what retained earnings are, how to calculate them, and how they strengthen your business.
Published Wednesday 17 June 2026
Table of contents
Key takeaways
- Retained earnings are the cumulative net profits your business keeps after paying expenses, taxes, and distributions to owners.
- Calculate retained earnings by adding net profit after tax to your previous retained earnings, then subtracting any payments made to owners.
- You can use retained earnings to fund daily operations, invest in growth, build emergency reserves, or pay down debt without taking on external financing.
- Tracking retained earnings over time helps you understand your business's financial health and can influence how buyers or investors value your company.
What are retained earnings?
Retained earnings are the cumulative net profits a business keeps after paying expenses, taxes, and any distributions to owners. This money stays in the business rather than being paid out, and it's available to fund future growth, cover day-to-day operations, or handle unexpected costs.
When your business earns a profit, you have 2 options: distribute it to owners (as dividends or drawings) or keep it in the business. The portion you keep becomes part of your retained earnings. Over time, retained earnings grow as your business continues to generate profit and reinvest it.
Retained earnings are different from your cash balance. While they represent profits you've kept in the business, that money may already be tied up in assets like equipment, inventory, or property.
What are negative retained earnings?
Sometimes a business's retained earnings drop below zero. This is known as negative retained earnings, or an accumulated deficit.
Negative retained earnings occur when your total losses and distributions to owners exceed the profits you've accumulated over time. This can happen if your business has a run of unprofitable periods or if owners withdraw more than the business earns.
An accumulated deficit doesn't necessarily mean your business is failing. It's common for newer businesses that are still investing heavily in growth. However, if the trend continues, it can limit your ability to borrow, attract investors, or weather financial setbacks.
How to calculate retained earnings
You can calculate retained earnings using a straightforward formula. The calculation takes your starting balance, adds the current period's profit, and subtracts anything paid out to owners.
Retained earnings = beginning retained earnings + net profit after tax - payments to owners
Here's what each part means:
- Beginning retained earnings: the accumulated balance carried over from the previous period
- Net profit after tax: your business profit for the current period after all expenses and taxes
- Payments to owners:dividends, drawings, or distributions made to shareholders or owners during the period
Worked example for an Australian small business
Suppose you run a small landscaping business in Melbourne. Here's how the calculation might look at the end of the financial year.
- Beginning retained earnings (carried over from last year): $45,000
- Net profit after tax for this financial year: $80,000
- Drawings taken by the owner during the year: $50,000
Applying the formula: $45,000 + $80,000 - $50,000 = $75,000
Your retained earnings at the end of the financial year would be $75,000. This amount carries forward as your beginning retained earnings for the next period.
How retained earnings affect the balance sheet
Retained earnings appear as equity on your balance sheet. They sit alongside other equity items like contributed capital and represent the profits your business has accumulated and reinvested over time.
Australian accounting standards officially list retained earnings as one of the key classes of equity to be disclosed on a company's financial statements. They increase your business's net worth and represent money that belongs to the business, not creditors.
To understand how retained earnings fit into the bigger picture, consider the accounting equation:
Owner's equity = assets - liabilities
When you retain earnings, you either:
- Increase assets: the cash stays in your bank account or gets invested in equipment, inventory, or property
- Decrease liabilities: you use the money to pay down debts
Both outcomes boost your owner's equity, making your business financially stronger. For sole traders who can't sell shares, retained earnings are the main way to grow owner's equity over time.
Retained earnings vs net income
Retained earnings and net income are related but measure different things. Understanding the distinction helps you assess your business's financial position more clearly.
Net income (also called net profit) is the profit your business earns during a single accounting period, such as a quarter or financial year. It's calculated by subtracting all expenses and taxes from your total revenue for that period. You can see your net income on your profit and loss statement.
Retained earnings are cumulative. They represent the total profits your business has kept across all periods since it started, after accounting for any distributions to owners.
Think of it this way: net income tells you how much profit you made this year, while retained earnings tell you how much profit you've built up over the life of your business. At the end of each period, your net income flows into your retained earnings balance, minus any payments to owners.
A business can have strong net income in a given year but low retained earnings if it has distributed most of its profits to owners over time. Equally, a business with modest annual profits can build substantial retained earnings by consistently reinvesting rather than distributing.
What are retained earnings used for
Retained earnings give you a pool of funds to draw on without needing external financing. How you use them depends on your business goals and stage of growth.
Common uses for retained earnings include:
- Daily operations: cover payroll, rent, utilities, and other ongoing expenses
- Growth investments: purchase new equipment, open locations, hire staff, or fund marketing campaigns
- Product development: support research and development of new products or services
- Acquisitions: buy out competitors or complementary businesses
- Emergency reserves: build a financial buffer to survive economic downturns or unexpected challenges
- Debt reduction: pay down loans early to reduce interest costs and improve cash flow
Factors that influence retained earnings
Several factors determine how your retained earnings balance changes over time. Understanding these helps you make informed decisions about where your profits go.
- Profitability: the more profit your business generates after expenses and taxes, the more you have available to retain. Consistent profitability, measured by your net income, is the primary driver of retained earnings growth.
- Dividend or distribution policy: the amount you pay out to owners directly reduces retained earnings. Businesses that distribute a large share of profits will accumulate retained earnings more slowly.
- Operating expenses: rising costs for wages, rent, materials, or other overheads reduce net profit, leaving less available to retain.
- Tax obligations: your tax rate and any changes to tax legislation affect your after-tax profit, which in turn affects how much flows into retained earnings.
- Economic conditions: broader market conditions, such as a downturn in consumer spending or supply chain disruptions, can reduce revenue and squeeze profit margins.
- Reinvestment decisions: spending retained earnings on growth initiatives (like new equipment or hiring) temporarily lowers your cash balance but can drive future profitability.
Advantages and disadvantages of retained earnings
Retaining profits in your business has clear benefits, but there are trade-offs to consider. Striking the right balance between retaining and distributing earnings is a key financial decision.
Advantages
Keeping profits in the business gives you more flexibility and financial resilience.
- Provide cash reserves for unexpected expenses or opportunities.
- Enable expansion without taking on debt or selling equity.
- Reduce your reliance on external funding sources like bank loans.
- Strengthen your balance sheet, which can improve your borrowing terms if you do need finance.
- Give you the freedom to invest at the right time without waiting for loan approvals.
Disadvantages
Holding too much profit in the business can also create issues.
- Signal stagnation to potential investors if you hold excessive cash without a clear growth plan.
- Risk inefficiency if idle cash leads to wasteful spending decisions.
- Miss opportunities if unused funds could generate better returns through strategic investments.
- Create tension with owners or shareholders who expect regular distributions.
Businesses in some higher-risk industries may also be required by their lenders, or by industry regulations, to retain a certain portion of earnings. This is common for businesses with expensive assets that need liquid cash available for replacements. Cash flow conditions are improving for many small businesses: Xero Small Business Insights data shows Australian small businesses were paid in an average of 23.9 days in the December quarter 2025, a record low since the series began in 2017. Faster payments can mean more cash available to retain and reinvest.
What are retained earnings for sole traders and partnerships
For sole traders and partnerships, retained earnings work differently because owners can draw money whenever they need it for personal use. There are no formal dividend procedures to follow.
Key differences for sole traders and partnerships:
- Withdraw retained earnings at any time without board approval or formal dividend declarations.
- Reduce retained earnings automatically when you make drawings, which appear on the next balance sheet.
- Keep business and personal finances more fluid than with companies.
This flexibility is helpful, but it also means you need to be disciplined about tracking retained earnings. Without monitoring, it's easy to overdraw and weaken your business's financial position. Keeping an eye on your retained earnings balance helps you measure genuine business growth over time.
How retained earnings impact business valuation
If you're planning to sell your business or attract investors, retained earnings play an important role in how your company is valued. They're a signal of financial health and management discipline.
Buyers and investors look at retained earnings as part of your total equity. A healthy retained earnings balance shows that your business has consistently generated profits and reinvested them wisely. This can increase confidence in the business's future performance.
A strong retained earnings track record can:
- Increase the overall valuation of your business by demonstrating sustained profitability.
- Reassure buyers that the business can fund its own operations and growth without heavy borrowing.
- Provide evidence of sound financial management over time.
On the other hand, low or negative retained earnings may raise concerns. Buyers might question whether the business can sustain itself, or they may factor in the need for additional capital investment. If you're working towards a sale, building your retained earnings in the years leading up to it can strengthen your negotiating position. You can learn more in Xero's guide on how to value a company.
Simplify your retained earnings tracking with Xero
Tracking retained earnings manually can be time-consuming and prone to errors, especially as your business grows. Xero accounting software can help simplify the process by automating calculations and updating your balance sheet in real time.
With Xero, you can see how your retained earnings change each period through a clear dashboard. This helps you make confident decisions about reinvesting in your business, paying down debt, or planning for future growth. It can help take the guesswork out of your finances, so you can focus on running your business. Get one month free.
FAQs on retained earnings
Here are frequently asked questions about retained earnings.
Is retained earnings debt or equity?
Retained earnings are a component of owner's equity, not debt. You'll find them listed in the equity section of your balance sheet, representing cumulative profits kept in the business.
How much should you keep in retained earnings?
The right amount depends on your business goals and stage of growth. If you're planning to expand, retaining more profits gives you a financial cushion; if your business is established, you might choose to distribute more to owners.
What happens to retained earnings when you sell your business?
Retained earnings form part of your business's total equity, which is factored into the sale price. A healthy retained earnings balance can strengthen your negotiating position and increase the overall valuation.
Are retained earnings the same as profits?
Not exactly. Profit (net income) is what your business earns in a single period, while retained earnings are the cumulative profits kept in the business across all periods after distributions to owners.
What is an accumulated deficit?
An accumulated deficit occurs when your total losses and distributions exceed cumulative profits, pushing retained earnings below zero. It's common in early-stage businesses investing heavily in growth.
What is a statement of retained earnings?
A statement of retained earnings is a financial report that shows changes to your retained earnings over a specific period. It starts with your opening balance, adds net income, subtracts distributions, and arrives at the closing balance.
Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.