Retained earnings
What retained earnings are, how to calculate them, and how they appear on your balance sheet.
June 2023 | Published by Xero
Published Thursday 6 August 2026
Table of contents
Key takeaways
- Retained earnings are the cumulative net profits a business keeps after paying expenses, taxes and any payments to owners.
- You calculate them by adding net profit after tax to previous retained earnings, then subtracting dividends or owner drawings.
- Retained earnings appear under equity on the balance sheet, and they can turn negative when cumulative losses and payouts exceed cumulative profits.
- Small businesses use retained earnings to fund operations, invest in growth, or build a cash reserve for tougher times.
What are retained earnings?
Retained earnings are the net profits a business keeps after paying expenses, taxes and any payments to owners, to fund future activities. They represent the cumulative portion of profit that has been reinvested in the business rather than distributed to shareholders or owners.
Think of retained earnings as your business's savings account. Each time you turn a profit and choose not to pay it all out, that money stays in the business and adds to your retained earnings balance. The Corporate Finance Institute describes retained earnings as the accumulated profits kept for reinvestment or to pay down debt.
How to calculate retained earnings
The formula for retained earnings is: retained earnings = previous retained earnings + net profit after tax − payments to owners (or dividends). Three components make up this calculation.
- Previous retained earnings: the balance carried forward from the last accounting period
- Net profit after tax: the profit your business earned during the current period, after deducting all expenses and taxes
- Payments to owners or dividends: any amounts distributed to shareholders or withdrawn by owners
Here is a worked example in Hong Kong dollars. Suppose your business has previous retained earnings of HK$200,000. During the year, you earn a net profit after tax of HK$120,000 and pay HK$50,000 in dividends. Your new retained earnings would be HK$200,000 + HK$120,000 − HK$50,000 = HK$270,000.
Where retained earnings appear on the balance sheet
Retained earnings sit under shareholders' equity (or owner's equity) on the balance sheet. This section shows what the business owes to its owners after all liabilities have been settled.
The relationship follows a simple equation: owner's equity = assets − liabilities. Retained earnings are one component of equity, alongside any capital contributed by shareholders. When retained earnings grow, total equity increases, strengthening the financial position of your business.
What are retained earnings used for?
Businesses use retained earnings in several ways to support ongoing operations and future growth.
- Fund day-to-day operations and cover working capital needs
- Invest in growth, such as expanding into new markets or opening additional locations
- Support research and development (R&D) to create new products or services
- Buy another business through an acquisition
- Build a cash reserve for unexpected expenses or economic downturns
- Pay down debt to reduce interest costs and improve financial flexibility
Retained earnings vs net profit
Net profit and retained earnings are related but distinct. Net profit is the profit your business earns during a single accounting period (such as a month, quarter or year) after subtracting all costs from revenue.
Retained earnings, by contrast, is a cumulative figure. It is the total amount of profit your business has kept over its entire lifetime, after dividends have been paid. Each period's net profit adds to retained earnings (or reduces them if there is a loss), while each dividend payment subtracts from the total.
To keep these terms clear: gross profit is revenue minus cost of goods sold, net profit is gross profit minus all other operating expenses and taxes, and retained earnings is what remains of net profit after payments to owners.
Negative retained earnings
Retained earnings can turn negative when cumulative losses and dividend payments exceed cumulative profits over time. This situation is called an accumulated deficit and appears as a negative figure on the balance sheet.
A negative balance does not necessarily mean a business is failing. Start-ups and younger companies often report accumulated deficits as they invest heavily in growth before becoming consistently profitable. However, a prolonged accumulated deficit can signal deeper financial problems and may limit access to financing or discourage investors.
Rules, pros and cons of retained earnings
From an accounting perspective, retained earnings are reported under owner's equity on the balance sheet and detailed on the statement of changes in equity. Certain businesses, particularly those in higher-risk or asset-heavy industries, may be required by law or lenders to maintain minimum retained earnings levels to keep the business financially stable.
High retained earnings can signal that a business is financially healthy and well-positioned to fund its own growth without relying on external debt. However, retaining too much cash over long periods can also suggest stagnation or inefficiency, as the funds could potentially generate higher returns if deployed strategically or returned to owners.
Low retained earnings might indicate a business that is reinvesting aggressively, paying generous dividends, or simply struggling to generate consistent profits. Context matters: a growing company may deliberately keep retained earnings low to fund expansion, while a mature business with the same balance may face questions about profitability.
Retained earnings for sole proprietors and partnerships
Sole proprietors and partners do not typically pay themselves formal salaries or dividends. Instead, they draw money from the business as needed, recording these amounts as owner's drawings.
When an owner takes a drawing, the business reduces its retained earnings on the next balance sheet. The mechanics are similar to dividends in a company: profit earned increases retained earnings, while drawings decrease them. Tracking these movements helps owners understand how much of their accumulated profit remains available in the business.
Track your retained earnings with Xero
Keeping an eye on retained earnings helps you understand how your business is building financial strength over time. With Xero's financial reporting tools, you can run balance sheets and equity reports in moments, giving you a clear view of where your profits go.
Ready to take control of your business finances? Get one month free and see how Xero makes tracking retained earnings and other key metrics straightforward.
FAQs on retained earnings
Below are answers to common questions about retained earnings.
Are retained earnings an asset?
No, retained earnings are not an asset. They are part of equity, representing profits that have been reinvested in the business. While assets fund the business, retained earnings reflect ownership claims on those assets after liabilities are paid.
Are retained earnings a debit or credit?
Retained earnings normally carry a credit balance. A debit balance would indicate an accumulated deficit, meaning cumulative losses and dividends have exceeded cumulative profits.
What is the difference between retained earnings and revenue?
Revenue is the total income your business earns from sales or services before any costs are deducted. Retained earnings is the cumulative profit kept in the business after all costs, taxes and dividend payments have been subtracted over time.
What is a statement of retained earnings?
A statement of retained earnings is a short financial report showing how retained earnings changed during a specific period. It lists the opening balance, adds net profit (or subtracts a loss), deducts dividends paid, and arrives at the closing retained earnings balance.
Related terms
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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.