Is Retained Earnings an Asset?

Retained Earnings
5
min read
November 9, 2021

As a small business owner, it’s always nice to have a positive cash flow. Maybe it’s time you finally pay off an expensive piece of equipment you purchased years ago or even invest in one that can make your business run faster. And while you might be excited about all your plans to use your profits, what's something you're not so excited about? Figuring out where to record those profits on your balance sheet. That's where retained earnings come into play. A retained earnings account can help you track your residual income.


In this guide, we’ll cover some basic bookkeeping questions such as, “Is retained earnings an asset?” 


Keep reading to learn: 

What Are Retained Earnings?

Retained earnings (RE) are profits from your company that can be used for investing or paying off debts. They’re essentially the income leftover (or net profit) after a business has paid shareholder dividends. On the balance sheet, retained earnings is a cumulative calculation of net income minus net dividend payments.


In other words, money in the retained earnings account serves as a business cash reserve or working capital. And by calculating retained earnings over time, you can get a sense of your business’s profitability. 

Reinvestment of Retained Earnings

Businesses can reinvest retained earnings by purchasing more capital (increasing assets) or paying off debts (reducing liabilities). 


Examples of reinvestment include:



Let’s say, for example, you own a construction company, and you want to invest in profit-producing activities using your retained earnings account. 


You may decide to purchase equipment or hire more employees, which empowers you to take on more higher-paying jobs.

Paying Dividends with Retained Earnings

On the other hand, you could decide to keep your money in your retained earnings account and use it to pay future cash or stock dividends.


Typically, companies strike a balance between reinvestment and paying dividends. 


Companies in a growth phase tend to reinvest more of their surplus into the business, whereas a mature company may opt to pay more dividends when it has a surplus.

How To Calculate Retained Earnings

Now that you know what counts as retained earnings, how do you calculate them? You’ll need to know your previous retained earnings, your net income and the dividends you’ve paid. You should be able to find your previous retained earnings on your balance sheet or statement of retained earnings. Your net income is either on your income statement or P&L (profit and loss) statement. And, finally, dividends is what you’ve paid your shareholders. 

 

The formula for calculating retained earnings is as follows: 


Retained Earnings = Beginning Retained Earnings + Net Income (or Net Loss) - Dividends Paid


Note: Beginning Retained Earnings are the same thing as previous retained earnings, and dividends can include cash dividends and stock dividends.

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If you’re a new business, put in a $0 for retained earnings, and if your retained earnings were in the negative, make sure to mark that as well. You could have negative retained earnings if you have a net loss and negative or low previous retained earnings.


You can use this calculator to figure out your retained earnings account’s balance at the end of your accounting period.

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Example of Retained Earnings Formula

It’s been a good year, and you have beginning retained earnings of $75,000 and for this accounting period, your net income was $90,000. You also paid dividends of $60,000.

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Retained Earnings = Beginning Retained Earnings + Net Income (or Net Loss) - Dividends Paid

 

Retained Earnings = $75,000 + $90,000 – $60,000
Retained Earnings = $105,000

Your retained earnings balance is $105,000, and you can decide if you want to reinvest that money and/or pay off debts with it.

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Now, let’s say you’ve struggled a bit this year (it happens to the best of us) and your retained earnings are in the negative. You have beginning retained earnings of $12,000 and a net loss of $36,000. You didn’t actually pay any dividends.

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Retained Earnings = Beginning Retained Earnings + Net Income (or Net Loss) - Dividends Paid

 

Retained Earnings = $12,000 + (– $36,000) – $0
Retained Earnings = -$24,000

Your deficit is $24,000, which means you’ll have to use -$24,000 as your beginning retained earnings during your next accounting period AND your net income will need to be high enough to get you out of the red.

Are Retained Earnings an Asset?

Technically, shareholders can claim the money in the retained earnings account. That’s why it’s called retained earnings. But, instead of withdrawing the funds, they’re retaining the money to reinvest in the business or save to pay future dividends. 


So, no, retained earnings are not considered an asset on a balance sheet. They’re reported as a line item on the shareholder’s equity section of the balance sheet rather than the asset section. While you can reinvest retained earnings as assets, they are not assets on their own.


Note: Shareholder’s equity is the value of business assets owned by investors. For sole proprietors, this section is referred to as owner’s equity because there is one owner. 

Where Do I Record Retained Earnings?

Typically, businesses record their retained earnings on a balance sheet. A balance sheet is a financial statement made up of total assets, liabilities and owner’s equity. Assets are the items of value that you own; liabilities are what you owe; and equity is the money you have left after paying down debts. 


Retained earnings are a line item in the equity section and help you figure out your total equity.


You could also elect to record retained earnings on separate statement of retained earnings.  Like the retained earnings formula, the statement of retained earnings lists beginning retained earnings, net income or loss, dividends paid, and the final retained earnings.

Comparing Retained Earnings with Revenue

Both retained earnings and revenue can give you some valuable information about the success of your company. However, there are differences in how the values are calculated and where they’re reported. 


Retained earnings is the cumulative measurement of net income left over, subtracting net dividends. 


Revenue, also known as gross sales, is calculated as the total income earned from sales in a given period of time. Since it doesn’t subtract the cost of goods sold, revenue is a good measurement of the demand for a business’s offerings. 


When you subtract net expenses (including operating expenses) from revenue, you get net income, which is a key part of the retained earnings calculation.


Retained earnings and revenue are both included on the company’s income statement and balance sheet. 


However, unlike retained earnings, revenue is reported as an asset on the balance sheet. 

Know How Much You Can Invest with Retained Earnings

Deciding how to invest net income is an essential task for any small business owner and retained earnings can tell you how much you’re working with before you make any major investments. Or you can use retained earnings to pay off debts and take that stress off your shoulders.


No matter how you decide to use your retained earnings, it’s important to keep your books straight and make sure you report all income and expenses in the right place.

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