How to Prepare a Statement of Retained Earnings

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

What is a statement of retained earnings? In this guide, we’ll explain everything you need to know about this financial statement, including what it is, how to prepare it, and why it’s important for your business. 

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. As we mentioned above, 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
$35,000
Net profit for the year ending 12/31/20XY
$150,000
Business license search
$99
Dividends paid
$135,000

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
$135,000
$135,000
Net profit for the year ending 12/31/20XZ
$175,000
$175,000
Dividends paid
($75,000)
($75,000)
Retained earnings at 12/31/20XZ
$100,000
$235,000
$335,000

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.

The Bottom Line

In small businesses, the statement of retained earnings can serve to give you clarity on how your business has accumulated and used its profit over time. However, this statement isn’t critical for business operations, and so it isn’t often produced for small businesses.

The statement of retained earnings does come in handy when your financial statements are prepared for outside entities, like investors and lenders.

Investors—both current and potential—like to see how a company uses its profits. They want to know the company is using their investment dollars wisely and that they will ultimately see a return on that investment. A business that reinvests a portion of its profits into helping the business grow—while still paying out dividends—will remain attractive to existing investors and could help attract new ones.

Lenders, on the other hand, use your historical financial statements to predict how you’re likely to run your business in the future. A statement of retained earnings that shows you are retaining profits in your business rather than distributing them all will improve your lenders’ confidence in your business’s ability to repay its obligations.

Billie Anne Grigg

Billie Anne Grigg has been a bookkeeper since before the turn of the century (yes, this one). She is a QuickBooks Online ProAdvisor, LivePlan Expert Advisor, FreshBooks Certified Beancounter, and a Mastery Level Certified Profit First Professional. She is also a guide for the Profit First Professionals organization. Billie Anne started Pocket Protector Bookkeeping in 2012 to provide an excellent virtual bookkeeping and managerial accounting solution for small businesses that cannot yet justify employing a full-time, in-house bookkeeping staff.
Read more