Retained earnings
Retained earnings are the profits your business keeps to reinvest. Learn how to calculate them and why they matter.
June 2023 | Published by Xero
Published Thursday 23 July 2026
Table of contents
Key takeaways
- Retained earnings are the cumulative net profits a business keeps rather than paying out to owners, so it can reinvest in future activities.
- You work them out with a simple formula: beginning retained earnings plus net profit, minus any payments to owners.
- Retained earnings sit in the equity section of the balance sheet, not as an asset, and they lift owner's equity as they grow.
- Negative retained earnings, known as an accumulated deficit, show that total losses and payouts have outweighed profits over time.
What are retained earnings?
Retained earnings are one of the clearest signs of whether a business is building financial strength over time. Here's the plain-English definition before we get into the detail.
Retained earnings are the net profits a business holds onto, rather than paying them to owners, so it can help fund future activities.
Once you've paid your expenses and taxes, you're left with net profit. You can either distribute that profit to owners or keep it in the business. Any profit you keep and carry forward is called retained earnings, and it builds up year after year.
How to calculate retained earnings
You can calculate retained earnings with a short formula that builds on the balance you already carried into the period. It adds this period's profit and subtracts anything paid out to owners as dividends.
The formula is: retained earnings = beginning retained earnings + net profit − payments to owners (dividends).
Say you start the year with $20,000 in retained earnings. Over the year your business makes $15,000 in net profit, and you pay $5,000 to the owners. Your closing retained earnings are $20,000 + $15,000 − $5,000, which comes to $30,000 to carry into the next period.
Are retained earnings an asset or equity?
This is a common point of confusion, so here's the direct answer. Retained earnings are equity, not an asset.
They belong in the equity section of the balance sheet, alongside owner's equity or shareholders' equity. Assets are the things your business owns, like cash, equipment, or stock. Retained earnings are profit you've chosen to keep, and that kept profit adds to what the business is worth to its owners.
How retained earnings affect the balance sheet
Retained earnings feed straight into your balance sheet and shift the overall value of the business. Here's how that plays out.
Retained earnings are effectively a chunk of cash in the business bank account, or they get turned into other assets that go on the balance sheet. Either way, they push up the net worth, or owner's equity, of the business.
The relevant formula is: owner's equity = assets − liabilities.
If liabilities (debts) stay constant, then an increase in assets will drive up owner's equity. Even if that money is spent straight away, it will still improve owner's equity by either increasing assets (for example, adding new equipment) or lowering liabilities (for example, paying debts).
The other way to increase owner's equity is by selling shares in the business. So retained earnings are the main way that sole traders, who can't sell shares, can grow owner's equity.
What negative retained earnings mean
Retained earnings won't always be a positive number. When they turn negative, accountants call it an accumulated deficit.
Negative retained earnings mean the total losses and payments to owners over the life of the business have outweighed its total profits. It often shows up in newer businesses still working towards profitability, or after a run of tough trading years.
An accumulated deficit isn't automatically a crisis, but it's worth watching. It can make it harder to secure finance, so it helps to understand what's driving it and to plan how to rebuild profit over the coming periods.
What are retained earnings used for
Retained earnings give you a pool of your own money to put back into the business. There are plenty of practical ways to use them.
Retained earnings may be used to:
- fund normal operations
- invest in growth (for example, new equipment, locations, hiring, or marketing)
- support research and development (R&D) of new products or services
- buy out another business
- build a rainy day fund so the business can survive disruptions
- accelerate debt repayments, if it makes financial sense to do so
Retained earnings vs net profit
Retained earnings and net profit are closely linked, but they're not the same thing. Keeping them distinct helps you read your accounts correctly.
Net profit is what's left in a single accounting period after you've paid all your expenses and taxes. Retained earnings are cumulative: they're the running total of net profit you've kept in the business across every period, minus any payments to owners.
Put simply, each period's net profit flows into retained earnings once you've decided how much to pay out. Net profit is a snapshot of one period, while retained earnings track the whole story over time.
Rules, pros and cons for retained earnings
Retained earnings come with a few reporting rules and some trade-offs worth weighing up. Here's what to keep in mind.
Retained earnings are reported on the balance sheet, in the section on owner's equity. They're also reported on the statement of changes in equity.
As noted, they can fund ongoing operations, growth, R&D, mergers and acquisitions, or they can be saved to build financial resilience. Businesses in some higher-risk industries may be required by law, or by their lenders, to retain a certain portion of earnings. This is typically required of businesses that have expensive assets, as they'll need liquid cash to replace those assets if something goes wrong.
While retained earnings are good for growing and protecting a business, too many retained earnings may reflect stagnation. It can signal to investors that a business has run out of ideas to invest in and grow. The surplus of cash may also make the business inefficient.
What are retained earnings for sole traders and partnerships
Retained earnings work a little differently when there are no shares to sell. Here's how they apply to sole traders and partnerships.
Sole traders and partners typically draw money out of the business bank account as they need it in their personal lives. If business earnings fail to meet those needs, owners may end up drawing against retained earnings. This simply gets reflected in reporting for the next accounting period, with retained earnings being reduced on the next balance sheet.
Grow your business with retained earnings and Xero
Retained earnings are easier to track when your profit, balance sheet, and equity all live in one place. With Xero's cloud accounting software you can run real-time financial reports, see how much profit you're keeping, and make confident decisions about reinvesting it, so get one month free and take control of your numbers.
FAQs on retained earnings
Here are answers to some frequently asked questions about retained earnings to clear up the points that trip people up most.
What do negative retained earnings mean?
Negative retained earnings, or an accumulated deficit, mean your total losses and payouts to owners have outweighed your total profits over time. It's common in newer businesses and isn't always a warning sign, but it's worth understanding what's causing it.
Are retained earnings an asset or a liability?
Retained earnings are neither an asset nor a liability: they're part of equity on the balance sheet. They represent the profit you've kept in the business rather than something you own or owe.
Are retained earnings the same as net profit?
No, retained earnings are the cumulative profit you've kept across many periods, while net profit is what a business earns in a single period after expenses and taxes. Each period's net profit adds to retained earnings once you've paid out any dividends.
Where do retained earnings sit on the balance sheet?
Retained earnings sit in the equity section of the balance sheet, under owner's equity or shareholders' equity. They also appear in the statement of changes in equity.
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.