What Are Retained Earnings?
Retained earnings are the running total of a company's profits that have been kept in the business instead of paid out to shareholders as dividends. Every period, net income adds to the balance and dividends subtract from it, so the account reflects the company's entire history of profitability and payout decisions.
The balance appears in the shareholders' equity section of the balance sheet and is the main link between the income statement and the balance sheet.
Formula
The roll-forward is simple: Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends. If a company loses money or pays out more than it earns, retained earnings shrink, and persistent losses can push the balance negative, a position called an accumulated deficit.
Note that retained earnings are not a pile of cash. The profits may have been reinvested in inventory, equipment, acquisitions, or debt repayment, so a large retained earnings balance says nothing about how much cash is actually on hand.
Example
Suppose a company begins the year with $800 million of retained earnings, earns $150 million of net income, and pays $50 million in dividends. Ending retained earnings equal $800 million + $150 million - $50 million = $900 million. This linkage is exactly how the income statement flows into the balance sheet in a three-statement model.
Why It Matters
Retained earnings reveal how a company balances reinvestment against returning capital to shareholders. Fast-growing companies typically retain nearly everything to fund expansion, while mature businesses pay out a larger share as dividends and buybacks.
For anyone building financial models or preparing for banking interviews, retained earnings are the balancing mechanism that makes the three statements tie together, so knowing the roll-forward cold is essential.
