Retained earnings: what they are, how to calculate them, and why they matter
Learn what retained earnings are, how to calculate them, and how they affect your small business.
Published Thursday 23 July 2026
Table of contents
Key takeaways
- Retained earnings are the portion of your net profits that you keep in your business rather than paying out to owners. They appear in the owner's equity section of your balance sheet.
- You can calculate retained earnings with a simple formula: beginning retained earnings + net income (or minus net loss) - dividends paid = ending retained earnings.
- Retained earnings fund daily operations, growth investments, debt reduction, and emergency reserves, all without requiring outside funding or loans.
- Low or negative retained earnings can signal financial trouble to lenders, while strong retained earnings improve your borrowing capacity and overall financial position.
Retained earnings definition
Retained earnings are the accumulated net profits your business has kept over time, rather than distributing them to owners as dividends or draws. They represent money you've reinvested back into your company.
On your balance sheet, retained earnings appear in the owner's equity (or stockholders' equity) section. Every time your business earns a profit and doesn't pay it all out, your retained earnings balance grows.
Retained earnings are different from revenue and net income. Revenue is the total money your business earns from sales before any expenses. Net income is what's left after you subtract all expenses and taxes from revenue. Retained earnings are what remains after you also subtract any dividends or owner draws from net income, accumulated across every period your business has operated.
Retained earnings formula and how to calculate them
Calculating retained earnings helps you track how much profit your business has built up over time. The formula is straightforward.
Retained earnings = beginning retained earnings + net income (or - net loss) - dividends paid
Here's what each part means:
- Beginning retained earnings: your retained earnings balance at the start of the period, carried over from the previous period
- Net income (or net loss): your total profit or loss for the current period after all expenses and taxes
- Dividends paid: any money distributed to owners or shareholders during the period
Worked example
Say your small business starts the year with $50,000 in retained earnings. During the year, you earn $30,000 in net income and pay $10,000 in dividends to shareholders.
Retained earnings = $50,000 + $30,000 - $10,000 = $70,000
Your ending retained earnings balance is $70,000. That's the total amount of profit your business has accumulated and kept, ready to reinvest or hold as a financial cushion.
What affects retained earnings
Several factors influence your retained earnings balance from one period to the next. Understanding them helps you make more informed decisions about your business finances.
The main factors that affect retained earnings include:
- Net income or net loss: profitable periods increase retained earnings, while losses reduce them
- Dividend payments: any distributions to shareholders directly reduce your retained earnings balance
- Owner draws: in sole proprietorships and partnerships, personal draws reduce retained earnings the same way dividends do for corporations
- Prior-period adjustments: corrections to accounting errors from previous periods can increase or decrease your retained earnings
Other factors play a role over the longer term. Your business's age matters, because newer companies typically have lower retained earnings simply because they haven't had as many profitable periods. Your industry's seasonality can also create swings in retained earnings throughout the year. And your dividend policy, or how much you choose to distribute versus reinvest, directly shapes how quickly retained earnings grow.
Negative retained earnings
Negative retained earnings occur when your accumulated losses exceed your accumulated profits. This is sometimes called an accumulated deficit.
There are several common causes of negative retained earnings:
- Sustained operating losses over multiple periods
- Large one-time expenses, such as a major lawsuit settlement or equipment write-off
- Paying out more in dividends or draws than your business has earned
- Significant startup costs in the early years of a new business
Negative retained earnings can affect how lenders and investors view your business. Banks may be less willing to extend credit, and investors may see it as a sign of financial instability. However, negative retained earnings aren't always a red flag. Many startups and early-stage businesses operate at a loss for their first few years while they build a customer base and scale up operations.
How to interpret retained earnings
Your retained earnings balance tells you something about your business's financial health, but context matters. A single number doesn't tell the full story on its own.
High retained earnings generally signal that your business is consistently profitable and reinvesting in its own growth. They can also indicate financial discipline and a strong position for future opportunities, whether that's expanding into new markets, hiring staff, or weathering an economic downturn.
Low or negative retained earnings may raise concerns for lenders reviewing a loan application. However, they can be perfectly normal for early-stage businesses or companies that have recently made large investments. The key is whether the trend is moving in the right direction.
When evaluating retained earnings, compare them to your business's stage, industry norms, and recent investment decisions. A growing retained earnings balance over time is generally a positive sign, while a consistently declining balance may point to underlying profitability issues worth investigating.
What are retained earnings used for?
Retained earnings let you invest in your business's future without borrowing money or seeking outside funding. That capacity matters most in uncertain times: Xero Small Business Insights found that US small business sales grew just 2.4% year-over-year in 2025, roughly half the long-term average of 5.5%. That gap highlights the tougher conditions many small business owners deal with on the ground, even when broader economic indicators look strong.
Common uses for retained earnings include:
- Daily operations: covering payroll, rent, and supply costs during slow periods
- Growth investments: purchasing new equipment, opening additional locations, hiring staff, or funding marketing campaigns
- Product development: researching and testing new products or services
- Business expansion: acquiring competitors or complementary businesses
- Emergency reserves: building cash reserves for unexpected disruptions or economic downturns. Xero Small Business Insights data shows US small business sales growth dropped from 4.1% in the September 2025 quarter to just 0.9% in the December 2025 quarter, illustrating how quickly revenue conditions can shift
- Debt reduction: paying down loans early to reduce interest costs
Strong retained earnings can also improve your borrowing capacity. Lenders often look at your equity position when evaluating loan applications, and retained earnings are a major component of that equity. A healthy retained earnings balance can help you qualify for better loan terms when you do need to borrow.
How retained earnings affect the balance sheet
Retained earnings sit in the owner's equity (or stockholders' equity) section of your balance sheet. They're one of the main components that determine your business's net worth. To understand how all four financial statements work together, including the retained earnings statement, see Xero's guide for small businesses.
The basic equation for owner's equity is:
Owner's equity = assets - liabilities
Retained earnings improve this equation in 2 ways:
- Increasing assets: when you use retained earnings to buy equipment, inventory, or property, your total assets go up
- Reducing liabilities: when you use retained earnings to pay down loans or outstanding bills, your total liabilities go down
For example, if you use $10,000 in retained earnings to buy new equipment, your assets increase by $10,000. Your owner's equity rises by the same amount, strengthening your overall financial position.
The other way to increase owner's equity is by bringing in new investment, such as selling shares in your company. For sole proprietors who can't sell shares, retained earnings are the primary way to build owner's equity over time.
Retained earnings vs. net income and revenue
Retained earnings, net income, and revenue are related but measure different things. Understanding the distinctions helps you read your financial statements more accurately.
Retained earnings vs. net income
Net income is your profit for a single accounting period, such as a quarter or a year. It's the amount left after you subtract all expenses, taxes, and costs from your total revenue for that period.
Retained earnings, on the other hand, are cumulative. They represent the total net income your business has earned across all periods, minus any dividends or draws you've paid out. Think of net income as what you earned this year, and retained earnings as the running total of what you've kept in the business since it started.
Retained earnings vs. revenue
Revenue (sometimes called gross income or total sales) is the total amount of money your business brings in before subtracting any expenses. It's the top line on your income statement, also called a profit and loss statement.
Retained earnings are much further down the chain. To get from revenue to retained earnings, you first subtract all expenses and taxes to arrive at net income. Then you subtract any dividends or owner draws. The result is the amount that stays in the business. Revenue can be high while retained earnings are low if your expenses or distributions are large.
What are retained earnings for sole proprietors and partnerships?
If you're a sole proprietor or in a partnership, retained earnings work a bit differently than they do for corporations. You have more flexibility in how you access the profits your business has accumulated.
As a sole proprietor or partner, you can withdraw money from your business for personal expenses without a formal dividend declaration. These personal draws reduce your retained earnings balance on your next balance sheet, similar to how dividend payments reduce retained earnings for corporations.
Here's how personal draws affect your retained earnings:
- You take money from your business account for personal needs
- Your retained earnings balance decreases by the amount you withdraw
- Your owner's equity on the balance sheet goes down accordingly
- Draws aren't treated as wages, so no income tax is withheld at the time, but your business's net profits are subject to self-employment tax, and timing matters for cash flow. Talk to a tax professional about how draws affect your specific situation
Unlike corporations, you don't need board approval or a formal declaration to access your retained earnings. However, it's still important to track your draws carefully so you have an accurate picture of your business's financial position. For guidance on setting a draw amount that works for both your business and household, see how to pay yourself as a business owner.
Track and manage retained earnings with Xero
Understanding your retained earnings helps you make confident decisions about reinvesting profits, managing cash flow, and planning for your business's future. The key is having accurate, up-to-date financial data so you can see your equity position clearly.
Xero accounting software gives you real-time visibility into your financial position with automated bank feeds, balance sheet reports, and customizable equity tracking. You can monitor your retained earnings alongside your other key metrics, so you can see where your business stands. Get one month free.
FAQs on retained earnings
Here are answers to frequently asked questions about retained earnings.
What are retained earnings in simple words?
Retained earnings are the profits your business has earned over its lifetime that haven't been paid out to owners. They stay in the business and can be used for things like covering expenses, funding growth, or building a financial cushion.
Where do retained earnings appear on the balance sheet?
Retained earnings appear in the owner's equity (or stockholders' equity) section of the balance sheet. They sit alongside other equity items like contributed capital or owner investments.
Can a company have negative retained earnings?
Yes, a company can have negative retained earnings if its accumulated losses are greater than its accumulated profits. This is common for startups and businesses that have gone through periods of significant investment or restructuring.
Is it good to have high retained earnings?
High retained earnings generally indicate consistent profitability and financial stability. However, very high retained earnings could also suggest the business isn't distributing enough profit to owners or investing enough in growth opportunities.
Are retained earnings an asset?
No, retained earnings aren't an asset. They're a component of owner's equity on the balance sheet. However, the money represented by retained earnings is typically held as assets like cash, equipment, or inventory.
Can you take money out of retained earnings?
Yes, you can access retained earnings through dividend payments (for corporations) or personal draws (for sole proprietors and partnerships). Taking money out reduces your retained earnings balance and your overall owner's equity.
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.