Quick answer: What are retained earnings?
Retained earnings are the cumulative profit a business has earned since it started, minus everything paid out to its owners as draws, distributions, or dividends. The formula is beginning retained earnings + net income − distributions. It sits in the equity section of the balance sheet and is a historical total, not cash in the bank. BizBooks Pro keeps it accurate automatically: the balance sheet shows this year's profit on its own line until you run Year-End Close, which moves it into Retained Earnings with one dated, inspectable journal entry.
Open your balance sheet and somewhere in the equity section there's a line called Retained Earnings. For a lot of owners it's the least understood number on the page. It isn't money you can spend, it isn't this year's profit, and it can be negative even when the business feels healthy.
So what are retained earnings, exactly? They're the running scorecard of your business's entire history: every dollar of profit it has ever earned, minus every dollar it has ever handed back to its owners. This guide covers the formula, a three-year worked example, why the figure almost never matches your bank balance, what a negative number means, and the four bookkeeping mistakes that make retained earnings look wrong.
What Are Retained Earnings?
A business's equity — what the owners have a claim to after all debts are paid — comes from exactly two places. Either the owners put money in (contributions, capital, stock), or the business earned it and kept it. Retained earnings is the second bucket.
Every year, the business makes a profit or a loss. Some of that profit may go out to the owners. Whatever is left over gets added to retained earnings, and it stays there year after year. After a decade, the figure is a single number summarizing ten years of results and ten years of payout decisions.
That's why retained earnings lives on the balance sheet rather than the profit and loss statement. The P&L measures one period and resets to zero; retained earnings is permanent and only ever accumulates. The mechanism that connects them is the year-end closing entry, which sweeps each year's profit off the P&L and into retained earnings.
Are retained earnings the same as cash?
No — and this is the single most common misunderstanding. Retained earnings tells you where equity came from. It says nothing about where the money is now. Profit you kept may have bought a delivery van, paid down a loan, built up inventory, or be sitting in unpaid customer invoices. The cash is long gone into other assets, but the retained earnings figure still records that the profit was earned and kept.
The Retained Earnings Formula
The calculation is short:
Ending Retained Earnings = Beginning Retained Earnings + Net Income (or − Net Loss) − Owner Draws, Distributions, or Dividends
Three inputs, and you already have all of them. Beginning retained earnings is last year's ending figure. Net income comes from the P&L. Distributions come from your owner's draw or distribution accounts (see owner's draw vs salary for which is which — salary is an expense, draws are not).
How do you calculate retained earnings? A three-year example
Harbor Street Print Shop opened in 2023. Here's how its retained earnings developed:
| 2023 | 2024 | 2025 | |
|---|---|---|---|
| Beginning retained earnings | $0 | $12,000 | $30,000 |
| + Net income (loss) | $42,000 | $58,000 | ($9,000) |
| − Owner distributions | ($30,000) | ($40,000) | ($24,000) |
| Ending retained earnings | $12,000 | $30,000 | ($3,000) |
Look at 2025. A new competitor opened down the street, the shop lost $9,000, and the owner still took $24,000 to live on. The result: retained earnings turned negative, even though the business had banked $100,000 of profit over the previous two years. Nothing is miscalculated. Over three years the shop earned $91,000 in total and paid out $94,000, so its accumulated kept earnings really are $3,000 below zero.
Why does the balance sheet say $30,000 when the bank says $8,000?
At the end of 2024 Harbor Street showed $30,000 of retained earnings but only about $8,000 in the bank. Over its first two years it paid $14,000 cash for a wide-format printer and $4,000 off its equipment loan, and customers still owed it $4,000 at year end — $22,000 of kept profit that isn't sitting in the bank. The $30,000 of kept profit didn't disappear; it turned into a printer, a smaller loan, and receivables. Your cash flow statement is the report that walks you from one number to the other.
Retained Earnings by Business Structure
The concept is the same everywhere, but the labels change with your legal structure:
| Structure | What reduces it | How it's usually presented |
|---|---|---|
| Sole proprietor / single-member LLC | Owner's draws | Often rolled into an Owner's Equity or Capital account; many small-business ledgers still keep a Retained Earnings account for accumulated profit |
| Partnership / multi-member LLC | Partner draws | Tracked per partner in capital accounts, according to the operating agreement |
| S corporation | Shareholder distributions | Retained Earnings on the books; the tax return's separate accumulated adjustments figure may differ, so ask your CPA |
| C corporation | Dividends | Retained Earnings, reported separately from common stock and paid-in capital |
Whichever row you're in, the rule for GAAP-compliant double-entry books is the same: keep what the owners contributed separate from what the business earned. Mixing them hides whether the business is funding itself or being funded. Our GAAP for small business guide explains why that separation matters to lenders.
What Negative Retained Earnings Mean
A negative balance is called an accumulated deficit. It means lifetime losses plus lifetime payouts exceed lifetime profits. Whether that's a problem depends entirely on why:
- Young business, investing ahead of revenue. Normal. Most startups run a deficit for their first year or two while the owners' contributions cover the gap.
- One bad year in an otherwise profitable history. Usually fine, as long as the owners adjust how much they draw.
- Consistent profit, but draws that are larger still. This is the one to watch. The owners are taking out more than the business makes, and the difference is being funded by debt or by eating into the original capital. Banks look for exactly this pattern when you apply for a loan.
Why Your Retained Earnings Number Looks Wrong
When an accountant opens a small business's books for the first time, the equity section is where they look first — because it's where earlier mistakes pile up. The usual causes:
- Years that were never closed. If no closing entry was posted, past profits are still sitting in income and expense accounts, and retained earnings shows only the opening balance.
- Transactions posted straight to Retained Earnings. Clean-up entries, "fixes," and unexplained differences dumped into equity bypass the P&L entirely. The profit never appears in any year's report, and the balance stops reconciling.
- Prior-year corrections posted into the current year. When your CPA sends late adjustments, posting them this year repairs the balance sheet but distorts two years' profit. The fix is to reopen the prior year, post them there, and close again.
- Draws that were never closed out. If draw accounts accumulate forever instead of being closed to equity each year, retained earnings is overstated by every dollar the owner ever took.
Can I post transactions directly to retained earnings?
Almost never. Retained earnings should move through exactly two doors: the year-end closing entry, and — rarely — a documented correction of a prior-period error that your accountant has signed off on. Anything else belongs in an income, expense, asset, or liability account, where it will show up on the reports that are supposed to explain it. Running a trial balance before each close is the quickest way to catch something parked in the wrong place.
In BizBooks Pro: the balance sheet shows your Retained Earnings account plus a separate Net Income (Current Period) line for this year's profit, so the two are never blurred together. Under ⚙️ Company Settings → 📅 Year-End Close, BizBooks Pro finds fiscal years that were never closed (up to 10 years back), shows each year's net income before you approve anything, and posts one dated closing entry per year. Once a year is closed, a transaction dated inside it stops and asks before it can change a figure your tax return was built on.
Equity That Actually Reconciles
BizBooks Pro is GAAP-compliant double-entry accounting that runs on your own computer. It keeps this year's profit visible on its own line, closes each year into Retained Earnings with an entry you can inspect, and guards closed years against backdated changes. One flat annual price, no monthly fees.
Start Free 30-Day Trial Try Live DemoThe Bottom Line
Retained earnings is the running total of profit your business has earned and kept. Add each year's net income, subtract what the owners took out, and carry the result forward — forever. It isn't cash, it isn't this year's profit, and a negative figure is a signal worth understanding rather than a mistake to hide.
Because it's cumulative, it's also the number that punishes sloppy bookkeeping longest. A skipped close or an entry dumped into equity in 2021 is still distorting it today. Close every year, keep contributions and draws in their own accounts, and never post straight to retained earnings — and it will stay the most trustworthy line on your balance sheet.
Want the double-entry mechanics behind all this to click? Our free interactive double-entry accounting course lets you post entries and watch them flow into the financial statements, in a sandbox, at your own pace.
Frequently Asked Questions
What are retained earnings in simple terms?
Retained earnings are the total profit a business has earned since it started, minus everything it has paid out to its owners as draws, distributions, or dividends. The figure sits in the equity section of the balance sheet and grows each year the business earns more than it pays out. It is a running historical total, not a pot of money, so it tells you how much of the owners' stake in the business was built from kept profits.
How do you calculate retained earnings?
Ending retained earnings equals beginning retained earnings, plus net income for the period (or minus a net loss), minus owner draws, distributions, or dividends paid in the period. For example, a business that starts the year with $12,000 of retained earnings, earns $58,000, and distributes $40,000 to its owner ends the year with $30,000 of retained earnings.
Are retained earnings the same as cash?
No. Retained earnings record where equity came from, not where the money is now. Profit that was kept in the business may have been spent on equipment, inventory, or loan repayments, or may still be owed by customers. A business can show large retained earnings and very little cash, and the balance sheet explains the difference by showing which assets that kept profit turned into.
What does negative retained earnings mean?
Negative retained earnings, also called an accumulated deficit, means that the business's total losses plus total payouts to owners exceed its total profits since inception. It is normal for a young business still investing ahead of revenue. In an established business it usually means owners have been taking out more than the business earns, which lenders notice, because that gap is being funded by debt or by the owners' original capital.
Where do retained earnings appear on the financial statements?
Retained earnings appear in the equity section of the balance sheet, alongside owner contributions or common stock. Between year-end closes, most accounting software also shows the current year's net income as a separate equity line, because that profit has not yet been moved into retained earnings. Some businesses also prepare a statement of retained earnings that shows the beginning balance, net income, distributions, and ending balance for the period.
Can I post transactions directly to retained earnings?
Almost never. Retained earnings should change only through the year-end closing entry and, occasionally, through a documented correction of a prior-period error made on your accountant's advice. Posting everyday income, expenses, or clean-up entries straight to retained earnings bypasses the profit and loss statement, so those amounts never show up in any year's reported profit and the equity figure stops reconciling.
Related Articles
- Year-End Closing Entries: How to Close Your Books at Year End
- How to Read a Balance Sheet: A Small Business Owner's Guide
- Owner’s Draw vs Salary: How to Pay Yourself From Your Business
- How to Read a Cash Flow Statement: A Small Business Owner's Guide
- How to Read a Profit and Loss Statement: A Small Business Guide
- Financial Ratios for Small Business: The 8 Numbers That Show If You're Healthy
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