How to Prepare a Statement of Retained Earnings

The statement of retained earnings summarizes any changes in retained earnings over a specific period of time. See why creating a statement of retained earnings can be beneficial for your business.

The statement of retained earnings is used to summarize retained earnings activity for a specific period of time.

Known by a variety of names, including the statement of owner’s equity, statement of equity, or a detailed earnings statement, the statement of retained earnings can be prepared as a separate statement or as part of your business balance sheet or income statement.

Overview: What is a statement of retained earnings?

Before we talk about a statement of retained earnings, let’s first go over exactly what retained earnings are. Retained earnings are a portion of the net profit your business generates that are retained for future use.

Retained earnings does not reflect cash flow, but rather the money left over after financial obligations have been paid. If your business is publicly held, retained earnings reflect any profit that your business has generated that has not been distributed to your shareholders.

Your retained earnings balance will always increase any time you have positive net income, and it will decrease if your business has a net loss. Retained earnings can be used to purchase additional assets, pay down current liabilities, or they be held for possible future distribution.

The retained earnings statement outlines any of the changes in retained earnings from one accounting period to the next. While smaller businesses tend to run a retained earnings statement yearly, others prefer to prepare a retained earnings statement on a quarterly basis.

A statement of retained earnings can be created no matter which accounting method you’re using, though both accounts payable and accounts receivable balances would be eliminated in the equation if you’re using cash basis accounting in your business.

A retained earnings statement can also be created for very small businesses, even if you’re a sole proprietor, though dividends are paid only to you.

Benefits of creating a statement of retained earnings

Preparing a statement of retained earnings can be beneficial for a variety of reasons, including the following.

1. More informed decision-making

Preparing a statement of retained earnings can help business owners make better decisions when it comes to their business, including whether to reinvest funds back into the business, distribute earnings to shareholders, or a combination of the two.

2. Better communication with shareholders

Company shareholders appreciate the statement of retained earnings, as it provides them with information regarding their investment, the potential amount of money they may receive should dividends be paid out, as well as the financial health of the company they’ve invested in.

3. Useful information for creditors

Any time you’re looking to attract additional investors or apply for a loan, it’s helpful to have a statement of retained earnings prepared.

That’s because potential investors and creditors will want easy access to this information -- the statement of retained earnings will give potential investors a frame of reference for potential future dividends, while creditors will want to see that your business will be able to repay any loan or line of credit they may extend.

How to prepare a statement of retained earnings

Creating a retained earnings statement is a simple process using the retained earnings formula:

Beginning Retained Earnings + Net Income/Loss - Dividends Paid = Retained Earnings

The statement of retained earnings is formatted simply:

Your Company Name

Statement of Retained Earnings

For the Year Ended December 31, 2019

The first example shows an increase in retained earnings, while the second example shows a decrease.

Your Company Name

Statement of Retained Earnings

For the Year Ended December 31, 2019

A decrease in retained earnings is not necessarily cause for alarm, as any time you invest money back into your business, your retained earnings will likely decrease.

If you’re ready to create a statement or retained earnings, just follow these simple steps:

Step 1: Find the prior year’s ending retained earnings balance

This can be done in a variety of ways, including:

• Accessing the ending retained earnings from your balance sheet.
• Finding the balance on your general ledger.

Whether you obtain this information from last year’s ending balance sheet or this year’s beginning balance sheet, you’ll need to have this information in order to start preparing the statement of retained earnings.

Step 2: Add net income or net loss

You'll also need to calculate your net income or net loss for the period for which you are preparing your statement of retained earnings.

If you’re using accounting software, this process will be automatically completed for you, but if you’re managing accounting transactions manually, you’ll need to be sure to include all relevant business revenues and expenses, including depreciation, when you prepare your income statement.

Step 3: Subtract any dividends paid to your investors

If you have investors to whom you pay dividends, you would subtract the amount of dividends paid in this step. If you own a very small business or are a sole proprietor, you can skip this step.

However, if you have one or two investors in your business, you’ll want to list the amount of money distributed to them during this period.

Step 4: Calculate your period-ending retained earnings balance

Follow the simple formula for retained earnings, which is adding net income or subtracting net loss from your beginning balance, then subtracting the total dividends paid, if any. Congratulations: You’ve just calculated your retained earnings balance.

For example, let's create a statement of retained earnings for John’s Bicycle Shop. John’s year-end retained earnings balance for 2018 was $67,000, and his total net income for 2019 totaled $44,000.

John, his brother, and his sister are the sole investors in the bicycle shop. At the end of 2019, they each received a dividend in the amount of $7,000, with total dividends paid in the amount of $21,000. The following is John’s Bicycle Shop’s statement of retained earnings:

John’s Bicycle Shop

Statement of Retained Earnings

For the Year Ending December 31, 2019

At the end of 2019, John’s Bicycle Shop had retained earnings in the amount of $90,000, which can be used to invest back into the business, such as by purchasing a larger storefront. The money can also be distributed to John, his brother, and his sister as a dividend, or some combination of the two options.

The statement of retained earnings may be useful for your business

Not every business needs a statement of retained earnings, so it’s likely not included with the regular financial statements your bookkeeping staff typically prepares.

However, even small businesses can benefit from creating a statement of retained earnings, particularly if you’re looking to expand or attract investors, or if you’re thinking about applying for a business loan.

There’s no downside to creating a statement of retained earnings for your business, so why not take a few minutes and create one today?