Basic Formula for Calculating Retained Earnings

Basic Formula for Calculating Retained Earnings

In addition to explaining the basic formula used to calculate retained earnings, we’ll also look at the various advantages of not distributing all of a company’s profits. Even if a business isn't planning any new acquisitions, it’s still a good idea to keep some reserves.

·         Managing a company’s operations, marketing and sales activities and expense management are but a few of the decisions that management has to deal with. After it has made a profit the company will then need to decide what to do with those profits. Among the options for using profits are: operations, returning cash to shareholders, or keeping cash in reserve for future use. In this article we discuss how to calculate expanding the figure that is reported as retained earnings on balance sheets and presenting an overview of why a company would want to keep a reserve.

Retained earnings represent the amount a company has left after it has paid all its expenses, taxes, and dividends. A company can return all the cash it has left after it has taken care of its obligations, but that would handicap its efforts to expand operations, make acquisitions, and replace equipment. Some investors like when this figure is returned to them in the form of dividends, but most do understand that something must be reinvested for the long term.

·         Saving for the Future

The formula to calculate retained earnings is quite simple. The figure is calculated by adding the net profits (less dividends paid) to the beginning retained earning balance from a previous period:

Retained Earnings (RE) = Beginning RE + Net Income – Dividends

If there is a net loss and it is larger than the beginning retained earnings, there will be what is called negative retained earnings.