Retained earnings are one of the most important parts of any company’s financial health. Yet many people, especially beginners in accounting or business, find the term confusing. In this guide, we explain what are retained earnings in simple English. We break every idea into small parts, using short sentences so anyone can understand.

We will also explain what are retained earnings on a balance sheet, how they grow, why businesses keep them, and how companies use them in real life.

Let’s start from the very beginning.

Table of Contents

What Are Retained Earnings?

Retained earnings represent the part of a company’s net income that the business keeps instead of paying out as dividends to shareholders.

Think of it like this:

A company earns profit.
The company decides how much of that profit to pay its owners (shareholders).
The money that is kept inside the company is called retained earnings.

In simple words:
Retained earnings = profit that stays in the company.

This amount becomes a pool of money that helps the business grow, pay off debt, or save for the future.

It is different from revenue. It is also different from cash. It is only the profit left over after all expenses and dividends.

So, when someone asks, “What are retained earning?”, the answer is:
They are profits kept inside the company after paying shareholders.

Why Retained Earnings Matter

Retained earnings matter because they show how well a company has performed over time. They reflect long-term growth and management decisions.

Here are the main reasons they are important:

1. They show financial strength

A company with high retained earnings has made profits over many years. This usually means the business is stable and successful.

2. They fund future growth

Businesses use retained earnings to:

buy equipment
open new locations
hire employees
develop new products
invest in technology

All these help the company grow.

3. They reduce the need for loans

If a company has enough retained earnings, it does not always need to borrow money from banks. This reduces interest costs and improves financial safety.

4. They support long-term planning

Healthy retained earnings make it easier for a company to plan ahead. It can handle emergencies, survive slow periods, and make investments with less risk.

What Are Retained Earnings on a Balance Sheet?

Now let’s look at what are retained earnings on a balance sheet, because this is where the term is used most often.

Retained earnings appear in the Equity section of the balance sheet.

A balance sheet has three major parts:

Assets – what the company owns
Liabilities – what the company owes
Shareholders’ Equity – owners’ value in the company

Retained earnings are part of Shareholders’ Equity. This means they belong to the owners of the company.

On the balance sheet, retained earnings are shown as a single number. This number represents total earnings kept from the very beginning of the company up to today.

For example, if a company has been earning profits for 10 years and keeping some money each year, the retained earnings will reflect the sum of all those years, minus dividends paid.

How to Calculate Retained Earnings

The formula for retained earnings is simple:

Retained Earnings = Beginning Retained Earnings + Net Income – Dividends

Here’s what each part means:

Beginning retained earnings: the balance from the previous year
Net income: the profit earned during the year
Dividends: payments made to shareholders

Let’s look at an example.

Example Calculation

A company starts the year with:

Beginning retained earnings = $100,000
It earns Net income = $40,000
It pays Dividends = $10,000

Using the formula:

Retained Earnings = $100,000 + $40,000 – $10,000
Retained Earnings = $130,000

This is the amount shown on the balance sheet.

Retained Earnings vs. Net Income

Many beginners confuse retained earnings with net income. But they are not the same thing.

Here is the difference:

Net income is the profit earned during a specific period (like a month or year).
Retained earnings are the total profits the company has kept over many years.

Net income increases retained earnings. But retained earnings include all past profits, not just current earnings.

Think of net income as a single seed.
Retained earnings are the whole tree grown from many seeds over time.

Retained Earnings vs. Revenue

Another common misunderstanding is between revenue and retained earnings.

Revenue

Revenue is the total amount of money a business earns from selling products or services. It is the top line of the income statement.

Retained Earnings

Retained earnings are what remain after subtracting all expenses and dividends from revenue.

Simple example:
If a company makes $100,000 revenue but spends $80,000 on costs, its net income is $20,000.
If it pays $5,000 in dividends, then retained earnings go up by $15,000.

Why Companies Keep Retained Earnings

Companies keep retained earnings for many reasons. These reasons help the business stay strong and grow.

1. To reinvest in the business

Companies often use retained earnings to buy tools, machines, or technology. This improves operations and increases profits.

2. To reduce debt

Paying off loans using retained earnings lowers interest costs and makes the business safer.

3. To have emergency funds

Retained earnings act like a safety net. If sales drop or unexpected costs arise, the company has money to survive.

4. To expand

Businesses use retained earnings to open new branches, enter new markets, or create new products.

5. To increase shareholder value

When retained earnings are invested wisely, the company becomes more profitable. This increases stock value and benefits shareholders.

Can Retained Earnings Be Negative?

Yes, retained earnings can be negative. This is called an accumulated deficit.

Negative retained earnings mean:

the company has lost money over time
or it has paid out more dividends than it earned
or it had major expenses in the past

This does not always mean the company is failing, but it is a warning sign. It suggests the business must improve profits or reduce expenses.

How Retained Earnings Change Over Time

Retained earnings grow or shrink based on the company’s performance.

Retained earnings increase when:

The company earns a profit
The company pays small or no dividends
The company reduces expenses and boosts earnings

Retained earnings decrease when:

The company has a net loss
The company pays large dividends
The company writes off large expenses

Retained earnings change every accounting period. They are updated at the end of each year or quarter.

Where Retained Earnings Are Used in Real Life

Retained earnings are not just numbers on a balance sheet. They have real uses in the business world.

1. Buying equipment

Factories use retained earnings to buy machines. Offices use them to buy computers and software.

2. Opening new stores

Retail companies expand by using retained earnings to open new branches.

3. Developing products

Tech companies use retained earnings to create apps, software, or devices.

4. Marketing and advertising

Businesses spend retained earnings to run ads, attract customers, and grow sales.

5. Research and innovation

Pharma and biotech firms invest retained earnings in research to discover new medicines.

All these activities help a business grow stronger.

Retained Earnings as a Sign of Business Health

Investors and analysts look at retained earnings to judge the long-term health of a company.

High retained earnings usually mean:

the company has long-term profit
management is wise with money
the business is stable and promising

However, high retained earnings do not always mean success. If the company is not using them well, the money may sit idle. Investors prefer when retained earnings are used to create more value.

Low or negative retained earnings usually mean:

weaker performance
higher risks
financial issues
or a company still in early stages

Common Myths About Retained Earnings

Many people misunderstand retained earnings. Let’s clear up a few myths.

Myth 1: Retained earnings are cash

False. Retained earnings are not cash. They are an accounting figure. The company may have spent the cash already.

Myth 2: High retained earnings mean high profits

Not always. A company may earn small profits for many years, adding up over time.

Myth 3: Retained earnings must be paid to shareholders

No. The company decides when to pay dividends. There is no rule that retained earnings must be distributed.

Myth 4: Retained earnings show annual profit

No. Net income shows annual profit. Retained earnings show cumulative profit.

Final Summary

Retained earnings are the profits a company keeps instead of paying them out as dividends. They are shown under Shareholders’ Equity on the balance sheet and represent the financial strength of a company.

In simple terms, when someone asks what are retained earnings, the answer is:

They are the company’s saved profits.

Retained earnings help businesses grow, expand, and survive. They reduce the need for loans, support long-term planning, and show whether a company has been profitable over time.

Understanding what are retained earnings on a balance sheet helps you read financial statements more confidently. It also helps you understand how businesses manage money.

What Are Retained Earnings? A Complete and Simple Guide