Retained earnings
Retained earnings are the profits your business keeps to reinvest, rather than paying out to owners.
June 2023 | Published by Xero
Published Thursday 23 July 2026
Table of contents
Key takeaways
- Retained earnings are the profits your business keeps after paying expenses, taxes and any dividends, ready to fund future activities.
- You calculate them with a simple formula: beginning retained earnings plus net income or loss, minus dividends.
- Retained earnings sit in the owner's equity part of your balance sheet, and they can be negative when losses or drawings add up over time.
- Holding some earnings back supports growth and resilience, though sitting on too much can point to missed chances to reinvest.
What are retained earnings?
Retained earnings are the net profits your business holds onto, rather than paying out to owners, so you can fund future activities. They build up over time and show how much profit you've reinvested back into the business.
Once you've paid your expenses and taxes, you're left with net profits. You can either distribute that money to owners or keep it in the business. The money you keep is your retained earnings.
How to calculate retained earnings
You work out retained earnings by starting with what you had at the beginning of the period, adding your profit or loss, then subtracting anything paid to owners. Here's the standard formula:
Retained earnings = beginning retained earnings + net income (or loss) − dividends
Say you started the year with $20,000 in retained earnings. Over the year you made $15,000 in net income and paid $5,000 in dividends to owners. Your retained earnings would be $20,000 + $15,000 − $5,000, which comes to $30,000.
What's the difference between net income and retained earnings?
People often mix these two up, so it helps to see them side by side.
Net income, sometimes called net profit, is the profit you make in a single period after all expenses and taxes. Retained earnings are the running total of net income you've kept in the business across every period, after taking out dividends. In short, net income feeds into retained earnings each period, but they aren't the same figure.
How retained earnings affect the balance sheet
Retained earnings show up on your balance sheet in the owner's equity section, so they play a direct role in your net worth. Let's look at how they move the numbers.
Retained earnings are effectively a chunk of cash in your business bank account, or they get turned into other assets. Either way, they push up the net worth, or owner's equity, of your business.
The relevant calculation is owner's equity = assets − liabilities. If your liabilities stay constant, an increase in assets drives up owner's equity. Even if you spend that money right away, it still improves owner's equity by adding assets, for example new equipment, or by lowering liabilities, for example paying off debts.
The other way to grow owner's equity is by selling shares. That's why retained earnings are the main route to growing equity for sole proprietors, who can't sell shares.
What are retained earnings used for?
Retained earnings give you a pool of funds to put back into the business. You can use them to:
- fund normal operations
- invest in growth, for example new equipment, locations, hiring or marketing
- support research and development of new products or services
- buy out another business
- build a rainy day fund so the business can survive disruptions
- accelerate debt repayments, when it makes financial sense
Can retained earnings be negative?
Yes, retained earnings can be negative, and this is more common than you might think. A negative balance is called an accumulated deficit.
An accumulated deficit happens when your total losses and dividends over time add up to more than your total profits. New and fast-growing businesses often see this while they invest heavily before turning a steady profit. It's a normal stage for many companies, though a long run of deficits is worth keeping an eye on.
Rules, pros and cons of retained earnings
Retained earnings come with a few reporting rules and some trade-offs worth weighing. Here's what to keep in mind.
You report retained earnings on the balance sheet, in the owner's equity section, and on the statement of changes in equity. Businesses in some higher-risk industries may be required by law, or by their lenders, to hold onto a set portion of earnings. That's typical for businesses with expensive assets, since they need liquid cash to replace those assets if something goes wrong.
Holding earnings back is good for growing and protecting your business, and it helps with managing cash flow. Sitting on too much, though, can point to stagnation. It can signal to investors that you've run out of ideas to invest and grow, and a surplus of idle cash can make the business less efficient.
Retained earnings for sole proprietors and partnerships
Retained earnings work a little differently when you run a sole proprietorship or partnership. Here's how drawings come into play.
Sole proprietors and partners typically draw money out of the business bank account as they need it for their personal lives. If business earnings fall short of those needs, you may end up drawing against retained earnings. That simply shows up in the next accounting period, with retained earnings reduced on the next balance sheet.
Manage your retained earnings with Xero
Keeping track of your retained earnings gets far easier when your profit, dividends and equity all live in one place. Xero brings your accounting equation together with real-time reports, so you can see how each period's profit flows into equity. Manage your finances, see your numbers clearly and grow with confidence when you get one month free.
FAQs on retained earnings
Here are answers to some frequently asked questions about retained earnings to help you put the term to work.
How do you calculate retained earnings?
Take your beginning retained earnings, add net income or subtract a net loss, then subtract any dividends paid to owners. The result is your retained earnings for the period.
Are retained earnings an asset?
No, retained earnings aren't an asset; they sit in the owner's equity section of your balance sheet. They can be held as cash or reinvested in assets, but the retained earnings figure itself represents equity.
Do you pay tax on retained earnings?
In Canada, retained earnings are what's left after your business has already paid income tax on its profits. That means they aren't taxed again at the company level.
What is a statement of retained earnings?
It's a short financial report that shows how your retained earnings changed over a period, from the opening balance through profit and dividends to the closing balance. In Canada it often appears as the statement of changes in equity within your financial statements.
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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.