Retained earnings
Learn what retained earnings are, how to calculate them, and why they matter for your business finances.
June 2023 | Published by Xero
Published Monday 17 August 2026
Table of contents
Key takeaways
- Retained earnings are the cumulative net profits your business keeps after paying dividends or drawings to owners, recorded in the equity section of the balance sheet.
- You calculate retained earnings by adding net profit after tax to the beginning balance and subtracting any payments to owners.
- A growing retained earnings balance typically signals profitability and reinvestment, while a negative balance indicates accumulated losses.
- Sole proprietors and partners don't pay dividends, but drawings beyond profits still reduce retained earnings.
What are retained earnings?
Retained earnings are the portion of net profits a business keeps rather than distributing to owners as dividends or drawings. These accumulated profits fund future activities such as expansion, debt repayment, or building cash reserves.
Each accounting period, your retained earnings balance updates to reflect profits earned and amounts withdrawn. Over time, this figure shows how much profit has been reinvested back into the business since it started.
How to calculate retained earnings
Working out your retained earnings requires just a few figures from your financial records. The formula is:
Retained earnings = beginning retained earnings + net profit after tax − payments to owners (dividends or drawings)
The beginning retained earnings balance is the closing balance from the prior accounting period. Once you add the current period's net profit and subtract any payments to owners, you get the ending retained earnings figure that carries forward.
Here's a worked example using pesos:
- Start with the beginning retained earnings balance: ₱200,000
- Add net profit after tax for the period: ₱120,000
- Subtract drawings taken by the owner: ₱40,000
- Calculate the ending retained earnings: ₱200,000 + ₱120,000 − ₱40,000 = ₱280,000
How retained earnings appear on the balance sheet
Retained earnings sit within the owner's equity (or shareholders' equity) section of the balance sheet. They also appear on the statement of changes in equity, which tracks movements during the period.
The relationship between equity and your other balances follows this formula: Owner's equity = assets − liabilities. Retained earnings contribute to your business's net worth by increasing the equity portion over time as profits accumulate.
What retained earnings are used for
Businesses put retained earnings to work in several ways. Common uses include:
- funding day-to-day operations
- investing in growth, such as new equipment, additional locations, hiring, or marketing
- supporting research and development
- acquiring another business
- building a cash reserve for unexpected disruptions
- accelerating debt repayments
Retained earnings vs net profit and dividends
These terms are related but have distinct meanings. Understanding the differences helps you read your financial statements accurately.
Net profit is what remains after subtracting all operating expenses and taxes from revenue. It measures profitability for a single accounting period. Retained earnings, by contrast, are the cumulative net profits kept in the business after paying dividends or drawings across all periods. Dividends are the portion of profits distributed to shareholders or owners rather than retained.
How to interpret retained earnings
The retained earnings balance can tell you a lot about how a business manages its profits. A growing balance generally signals consistent profitability and a commitment to reinvesting in the business.
However, a very large idle balance might indicate missed opportunities. If profits sit unused for extended periods, the business may not be deploying capital efficiently. Reviewing profitability ratios alongside retained earnings gives a fuller picture of financial health.
What negative retained earnings mean
When retained earnings fall below zero, this creates what's called an accumulated deficit. This happens when cumulative losses exceed cumulative profits, or when dividends and drawings exceed available earnings over time.
Negative retained earnings are common in early-stage businesses that haven't yet turned a profit. While not ideal, they don't necessarily signal failure, particularly for startups investing heavily in growth.
Retained earnings for sole proprietors and partnerships
Sole proprietors and partners don't receive formal dividends. Instead, they take drawings from the business as needed for personal use.
If drawings exceed profits during a period, the balance reduces retained earnings on the next balance sheet. This directly affects owner's equity, so tracking drawings carefully helps maintain an accurate picture of the business's financial position.
Track retained earnings with Xero
Xero's reporting tools make it simple to monitor your retained earnings over time. You can view the balance on your balance sheet report and trace movements through the statement of changes in equity. With up-to-date financial reports at your fingertips, you can make confident decisions about reinvesting profits or taking distributions. Ready to see your numbers clearly? Get one month free and start tracking your business finances today.
FAQs on retained earnings
Here are answers to common questions about retained earnings and how they work.
Are retained earnings an asset?
No, retained earnings are not an asset. They're part of owner's equity, representing the cumulative profits kept in the business rather than a specific resource the business owns.
Where are retained earnings on the balance sheet?
Retained earnings appear in the owner's equity (or shareholders' equity) section of the balance sheet, typically below contributed capital or share capital.
Are retained earnings the same as cash?
No. Retained earnings represent accumulated profits, but those profits may have been reinvested in inventory, equipment, or other assets. Your cash balance and retained earnings can differ significantly.
What is a good level of retained earnings?
There's no single target. A healthy level depends on your industry, growth plans, and cash flow needs. Aim to keep enough to cover planned investments and unexpected expenses while avoiding excess idle capital.
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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.