Retained Earnings

Each year, a company's net income is either paid out as dividends or kept in the business. The portion kept is added to retained earnings, which is part of shareholders' equity on the balance sheet.

The calculation is straightforward: opening retained earnings, plus net income for the year, minus dividends declared. If a company starts the year with retained earnings of 3 million, earns net income of 800,000 and pays dividends of 300,000, its retained earnings at year-end are 3.5 million.

Retained earnings do not sit in a separate pile of cash. The profits have usually been reinvested in assets such as equipment, inventory or new projects, or used to repay debt.

If a company makes losses, retained earnings fall and can become negative, which is often called an accumulated deficit. Young, fast-growing companies frequently have accumulated deficits because they have spent heavily before becoming profitable. Mature companies with long profit histories often have very large retained earnings.