retained earnings

Imagine a family business that, every year, earns a profit and faces a choice: hand the profit out to the owners, or leave it inside the business to grow. The slice they leave inside, year after year, piles up into a running total. For a corporation, that running total of profits kept in the business rather than paid out as dividends is called retained earnings.

Retained earnings is the accumulated net income a company has earned over its entire life, minus all the dividends it has ever distributed and minus any cumulative losses. The formula is simple: beginning retained earnings, plus net income for the period (or minus a net loss), minus dividends declared, equals ending retained earnings. For example, if a company starts the year with retained earnings of 100,000, earns net income of 40,000, and declares dividends of 15,000, it ends with 125,000. It sits inside stockholders' equity on the balance sheet, alongside contributed capital like common stock and additional paid-in capital.

Retained earnings matters because it is the bridge that links the income statement to the balance sheet: profit earned this period flows through net income into retained earnings, raising owners' equity. The essential caveat is that retained earnings is not a pile of cash. It is an accounting figure describing accumulated, reinvested profit; that profit may long ago have been spent on inventory, equipment, or paying down debt. A company can show large retained earnings and still have very little cash in the bank.