Financial statements are not only helpful when it’s time to file your small-business taxes — they also shed a light on your business’s finances. At some point in your business accounting processes, you may need to prepare a statement of retained earnings.

What is a statement of retained earnings? This guide explains everything you need to know.

What is a statement of retained earnings?

The statement of retained earnings shows changes in retained earnings from the beginning of a financial period to the end of that same financial period. This financial period is typically one year.

The statement of retained earnings can also be called a statement of shareholders’ equity. If your business is a sole proprietorship, your statement of retained earnings might be called something different, like a statement of owner’s equity or equity statement. Regardless of what it’s called, the statement of retained earnings follows the same basic formula:

Beginning retained earnings + net income – dividends = ending retained earnings

Retained earnings tell the story of what your business has done with its profit. It’s important to understand that retained earnings are not the same as cash retained in your business. In order to track the flow of cash through your business — and to see if it increased or decreased over a given period of time — you will need to review your statement of cash flows.

How to prepare a statement of retained earnings

With this formula in mind, let’s run through how to prepare a statement of retained earnings for your business.

Step 1: Determine the financial period

To start, you will first need to decide on the financial period for which you’ll calculate your retained earnings. This is typically one year, but you may also choose a month, quarter, etc.

Once you have defined your financial period, you will create a heading for your statement of retained earnings that includes the name of your company, the name of the report — otherwise known as “statement of retained earnings” — and the financial period.

Step 2: Calculate your beginning retained earnings

Retained earnings are the profits your business has earned and kept in the business. These are reported in the equity section of your balance sheet. According to the balance sheet equation (Assets = Liabilities + Equity), equity is what remains after all your creditors are paid from your business’s available assets.

Let’s say you’ve decided your financial period is one year, and you’re preparing a statement of retained earnings for the year 20XY. To continue, you’ll need the retained earnings from the previous year (20XX).

Suppose your business shows a net profit on your profit and loss statement of $50,000 for the year 20XX. Of that $50,000, you owe $15,000 in dividends to your shareholders (this can include you).

$50,000 net profit – $15,000 dividends = $35,000

The remaining $35,000 in this equation is your business’s retained earnings. This number will be your beginning retained earnings.

Step 3: Add net income

Next, you will add your net income from the current year (20XY) to the $35,000 beginning retained earnings. Again, you will find this number on your profit and loss statement.

In our example, let’s say your business has a net profit of $150,000 in the year 20XY. Your formula will now include:

$35,000 beginning retained earnings + $150,000 net profit = $185,000

Step 4: Subtract dividends

To complete the calculation, you’ll now subtract the dividends you need to pay out from the $185,000 to get your ending retained earnings. In our example, you must pay out $50,000 in dividends. To sum up, if the statement of retained earnings formula is:

Beginning retained earnings + net income – dividends = ending retained earnings

$35,000 + $150,000 – $50,000 = Ending retained earnings

$135,000 = Ending retained earnings

There you have it, you’ve successfully prepared your statement of retained earnings.

Statement of retained earnings example

A statement of retained earnings can range from extremely simple to very detailed. To illustrate, here are some statement of retained earnings examples. In its simplest form, using the example above starting in year 20XY, your statement of retained earnings would look something like this:

Statement of retained earnings

For the year ending 12/31/20XY

Retained earnings at 12/31/20XX

Net profit for the year ending 12/31/20XY

Business license search

Dividends paid

XX = Previous year, XY = Current year

But there can be a lot more than net profit in your retained earnings number. If you pay capital into your business and don’t take it back out again, that impacts your equity in the business.

Let’s say you invest $100,000 in your business in year 20XZ. This is an investment — not a loan you intend to repay yourself — and so it gets added to your equity in the business.

Your net profit for year 20XZ is $175,000 and you owe $75,000 in dividends to your shareholders.

In this case, you’ll want to expand your statement of retained earnings to reflect the paid-in capital. Your new statement of retained earnings would look like this:

Statement of retained earnings

Paid-in capital

Retained earnings

Total equity

Retained earnings at 12/31/20XY

Net profit for the year ending 12/31/20XZ

Dividends paid

Retained earnings at 12/31/20XZ

This shows exactly how your contributed capital in the business impacts the total equity in the business. If you issue stock in the business, the changes in that stock would also appear in the expanded statement of retained earnings.

A version of this article was first published on Fundera, a subsidiary of NerdWallet

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