What are retained earnings and how to calculate them

Published Wednesday 17 June 2026

Table of contents

• Retained earnings
• Why are retained earnings important?
• Understanding the components of retained earnings
• How to calculate retained earnings
• How retained earnings affect the balance sheet
• Retained earnings vs net income and revenue
• What are negative retained earnings?
• What are retained earnings used for
• Rules, pros and cons for retained earnings
• Factors that affect retained earnings
• What are retained earnings for sole traders and partnerships
• Track your retained earnings with Xero
• FAQs on retained earnings

Key takeaways

• Retained earnings are the portion of your net profit that stays in the business after you've paid dividends to owners or shareholders, and they reflect your company's ability to generate and reinvest profits over time.
• You can calculate retained earnings using a simple formula: beginning retained earnings plus net income minus dividends paid. Tracking this figure each accounting period helps you spot trends in your business's financial health.
• Retained earnings sit within the equity section of your balance sheet and directly increase your business's net worth, making them a cost-effective way to fund growth without taking on debt.
• For UK sole traders and partnerships, retained earnings work differently because owners typically draw funds as needed, so tracking drawings against earnings is key to understanding your true financial position.

Retained earnings

Retained earnings are the net amount left over at the end of an accounting period after you've distributed dividends to owners or shareholders. They show how much profit your business has kept and reinvested over time, rather than paid out.

A common misconception is that retained earnings are the same as profit. You use your gross profit to cover expenditure and taxes, which leaves your net profit (also called net income). Your net profit can then be shared with business owners and shareholders as dividends. Whatever remains after those payments is your retained earnings.

Retained earnings aren't an asset in themselves. They're a source of equity that can be used to buy assets, reinvest in the business, or increase payments to owners and shareholders.

Why are retained earnings important?

Retained earnings play a central role in your financial management. They help you evaluate your business's financial health and fund its growth.

If your business is in a growth-focused stage, retained earnings offer a cost-effective way to fund that growth without increasing external debts or giving away equity. You can use your own funds to pay for things like launching a new product, acquiring equipment, or increasing production capacity.

Retained earnings also help you track your company's financial position across multiple accounting periods. Strong retained earnings can influence your ability to pay dividends to shareholders. If you maintain healthy retained earnings, you could increase dividend payments, providing a better return on investment for your shareholders.

Once your company is profitable, you may be able to reduce or avoid external debts by using retained earnings to fund your business's future plans. Find out other ways to manage your finances and cash flow.

Understanding the components of retained earnings

3 main components make up the retained earnings calculation. Understanding each one helps you see where the figure comes from and how to influence it. If you're new to these concepts, the small business accounting guide covers the basics.

• Net income: your total revenue minus all expenses, taxes, and costs of goods sold for the period. This is the starting point for calculating how much profit is available to retain.
• Dividends paid: the portion of net income distributed to owners or shareholders. The more you pay out in dividends, the less you retain.
• Prior period retained earnings: the cumulative retained earnings carried forward from previous accounting periods. This balance rolls forward and grows (or shrinks) each period based on your net income and dividends.

How to calculate retained earnings

You can calculate your retained earnings at the end of every accounting period, whether that's monthly, quarterly, or yearly. Using the key financial components and the formula below, you can track your retained earnings across multiple periods to spot trends.

The retained earnings formula

The formula for calculating retained earnings is straightforward:

Retained earnings = Beginning retained earnings + Net income - Dividends paid

Start with your retained earnings balance from the previous period, add your net income for the current period, then subtract any dividends paid out. The result is your updated retained earnings figure.

Example of retained earnings calculation

Here's a simple example of how the retained earnings formula works in practice.

Say your beginning retained earnings are £200,000, your net income is £50,000, and your dividends are £10,000. The equation would be:

£200,000 + £50,000 - £10,000 = £240,000

Your new retained earnings figure would be £240,000. Running this calculation each accounting period lets you track whether your retained earnings are going up or down over time, and highlights whether you need to take action to strengthen your business's financial health.

How retained earnings affect the balance sheet

Retained earnings sit in the equity section of your balance sheet and directly affect your business's net worth. When retained earnings increase, your owner's equity increases too.

The relevant formula is:

Owner's equity = Assets - Liabilities

If your liabilities stay constant, an increase in assets drives up owner's equity. Even if retained earnings are spent straight away, they still improve owner's equity by either increasing assets (for example, adding new equipment) or lowering liabilities (for example, paying off debts).

The other way to increase owner's equity is by selling shares in the business. That makes retained earnings the main way sole traders, who can't sell shares, can grow their owner's equity. Learn more about owner's equity.

Retained earnings vs net income and revenue

It's easy to confuse retained earnings with net income and revenue, but each figure tells you something different about your business's finances.

• Revenue is the total income your business earns from sales and services before any costs are deducted. It's your top-line figure.
• Net income is what's left after you subtract all expenses, taxes, and costs from your revenue. It represents your profit for a single accounting period.
• Retained earnings are cumulative. They represent the total net income your business has kept over its entire history, minus all dividends ever paid out.

Think of it this way: revenue flows into net income after costs are deducted, and net income flows into retained earnings after dividends are paid. Revenue and net income are period-specific figures, while retained earnings are a running total that builds up over time. You can see this relationship clearly in a profit and loss statement.

What are negative retained earnings?

Negative retained earnings, sometimes called an accumulated deficit, occur when your total losses and dividend payments exceed your cumulative profits. In other words, your business has paid out or lost more than it's earned over its lifetime.

Several situations can lead to negative retained earnings:

• sustaining net losses over multiple accounting periods
• paying out more in dividends than you've earned in profit
• incurring large one-off expenses or write-offs that wipe out previous gains
• operating as an early-stage business that hasn't yet reached profitability

Negative retained earnings don't necessarily mean your business is failing. Start-ups and businesses making large investments often run a deficit in their early years. However, a persistent accumulated deficit can signal deeper problems with profitability and may make it harder to attract investors or secure financing.

What are retained earnings used for

Retained earnings give you a pool of funds to reinvest in your business. How you use them depends on your goals and stage of growth.

Common uses for retained earnings include:

• funding day-to-day operations
• investing in growth, such as new equipment, locations, hiring, or marketing
• supporting research and development (R&D) of new products or services
• buying out another business
• building a reserve fund so the business can survive disruptions
• accelerating debt repayments, if it makes financial sense to do so

Explore more ways of financing your business.

Rules, pros and cons for retained earnings

Retained earnings are reported on your balance sheet in the equity section. They also appear on the statement of changes in equity. You can use financial reporting tools to generate these reports.

On the positive side, retained earnings can fund ongoing operations, growth, R&D, mergers and acquisitions, or serve as a financial safety net. 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 the case for businesses with expensive assets that need liquid cash available to replace them if something goes wrong.

There are potential downsides, though. Too many retained earnings may reflect stagnation. It can signal to investors that a business has run out of ideas for investment and growth. A surplus of cash may also lead to inefficiency, as there's less pressure to deploy funds strategically.

Factors that affect retained earnings

Several factors influence whether your retained earnings grow or shrink over time. Understanding these helps you make more informed decisions about your business's finances.

• Profitability: higher net income directly increases your retained earnings, while losses reduce them. Consistent profitability is the single biggest driver of a healthy retained earnings balance.
• Company age: newer businesses typically have lower or negative retained earnings because they haven't had time to accumulate profits. As your business matures and earns consistently, retained earnings naturally build up.
• Dividend policy: the more you distribute as dividends, the less you retain. Striking the right balance between rewarding shareholders and reinvesting in the business is key.
• Seasonality: if your business has seasonal revenue patterns, your retained earnings may fluctuate through the year. Tracking them at the same point each year gives you a clearer picture of the trend.
• Financial management: how well you control expenses, manage cash flow, and time investments all affect how much profit you keep. Using accounting software to monitor your finances in real time helps you stay on top of these decisions.

What are retained earnings for sole traders and partnerships

Retained earnings work a bit differently if you're a sole trader or in a partnership. Unlike limited companies, sole traders and partners don't pay themselves formal dividends.

Instead, you typically draw money from the business bank account as you need it for personal expenses. If your business earnings don't cover those needs, you may end up drawing against retained earnings. This is simply reflected in reporting for the next accounting period, with retained earnings being reduced on the next balance sheet.

For sole traders and partnerships, tracking your drawings against your earnings is especially important. It helps you understand how much profit the business is genuinely retaining and whether you're building financial resilience or slowly depleting your reserves. Keeping accurate records of these movements makes self-assessment tax returns simpler and helps you plan ahead.

Track your retained earnings with Xero

Keeping on top of your retained earnings doesn't have to be complicated. With the right tools, you can track your profits, dividends, and equity in real time and make confident decisions about reinvesting in your business.

Xero's cloud accounting software gives you customisable financial reports, including balance sheets and profit and loss statements, so you can see your retained earnings at a glance. Automated bank feeds and reconciliation help save you time on manual data entry, while real-time dashboards help you spot trends as they develop. Get one month free.

FAQs on retained earnings

Here are answers to some frequently asked questions about retained earnings.

Can you pay dividends from retained earnings?

Yes, dividends are typically paid out of retained earnings. However, paying large dividends reduces the funds available for reinvestment, so it's worth weighing short-term shareholder returns against long-term business growth.

Are retained earnings a debit or credit?

Retained earnings carry a credit balance under normal circumstances. A debit balance in retained earnings indicates an accumulated deficit, meaning your business has incurred more losses than profits over time.

Can retained earnings be negative from day 1?

Yes. If your business makes a loss in its first accounting period, your retained earnings balance will be negative straight away. This is normal for new businesses and doesn't mean you've done anything wrong.

How often should you review retained earnings?

Review your retained earnings at least once per accounting period, whether that's monthly, quarterly, or yearly. Comparing the figure across periods helps you spot trends in profitability and make timely decisions about reinvestment or dividends.

Do retained earnings affect your ability to get a business loan?

Lenders often look at retained earnings as a sign of financial stability. A healthy, growing retained earnings balance can strengthen your case when applying for financing, while a persistent deficit may raise concerns.