Retained Earnings – How it Works

In the equity section of the balance sheet there is an account that tallies the lifetime earnings net of dividends for the company. The value identifies the total amount retained by the company for operational purposes. This account is referred to as the Retained Earnings of the business.  

For the average business owner understanding this account and the variables involved benefit the owner in comprehending the overall net worth of the company. Often the business manager and/or owner is the only shareholder in the small business. It is important to fully grasp the implication of the value to the single or few shareholders. This is one of many articles teaching the reader how to read the financial statements.

In this article I will define the term ‘Retained Earnings’ and explain the presentation formats in your balance sheet. In addition, I’ll walk through how this account accumulates its value over time by starting with the initial year of operations and then how it changes from year to year.  Finally, I explore how you interpret the information presented. 

Before I begin, if you are not familiar with the structure of the balance sheet or the equity section in the balance sheet, please read the two following articles as the information contained will benefit you greatly in understanding this particular subject matter: 

1. How to Read a Balance Sheet – Simple Format – a basic introduction to how the balance sheet is formatted and structured to identify assets and the corresponding bottom half of liabilities and equity.
2. How to Read a Balance Sheet – Equity Section (Simple Format) – a very basic introduction to the equity section for the novice or intermediate business entrepreneur.

Now that you have a basic understanding of the balance sheet and the equity section, let’s begin: 

Definition and Presentation Formats 

Every successful business operation reinvests their earnings back into the company. An owner often wonders how much has been reinvested or kept by the company. This is referred to as Retained Earnings.  

In the equity section of the balance sheet there are

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