The Right Method To Calculate Retained Earnings (With Examples).by Elena James Business analyst and Online Marketer
As a business owner, you clearly understand the importance of retained earnings of your business. Retained earnings meaning is to retain a certain amount of your profit aside to use in the future or in the case of emergencies. Consequently, retained earnings are shown under the ‘Reserve Capital’ header in the cash flow statement. The remaining profit, however, is distributed among shareholders as dividends. But what is the right method to calculate retained earnings for your business? This blog will give you key insights for calculating retained earnings for your business accurately.
How To Calculate Retained Earnings?
In the balance sheet, retained earnings are shown under the main head of ‘Shareholder’s Equity’. There is a quite simple formula for calculating retained earnings. You are required to know three main variables to calculate retained earnings for your business.
These three variables affect the retained earnings of your current accounting period. So, it is necessary to consider the three of them carefully. The three main variables for calculating retained earnings are as follows:
Existing Retained Earnings:
That’s right! You have to take your previous or existing retained earnings into consideration for calculating your retained earnings for this year. Existing retained earnings are the earnings that you have retained in the previous year and haven’t used yet.
Net Profit or Loss:
This is obviously the main aspect to calculate retained earnings for your business. After the deductions from gross total income, the result comes in either net profit or a net loss. You have to take this amount into the consideration, even if the result comes in a net loss.
The profit distributed among shareholders is known as dividends. You will need dividends to calculate retained earnings for your business firm. As you know, shareholders only get the part of the profit as dividend according to the shares they hold. For example, if a shareholder holds 1500 shares of a company, then he/she will get a dividend according to the 1500 shares only.
Beginning Retained Earnings Formula:
Now that, you have gained a basic understanding of the variables that you are required to calculate retained earnings. Let’s move on to the formula of calculating retained earnings:
Retained Earnings = Existing Retained Earnings + Net Profit/Loss - Dividends
To calculate retained earnings accurately, you have to take the Existing Retained Earnings and add Net Profit or Loss. After that, you have to deduct the Dividends payout because you are required to pay the dividend amount to the shareholders.
Retained Earnings Example:
Let’s understand the above-mentioned retained earnings formula with the help of an example.
Assume that a company has a net profit of $12,000 in the month of August. The company owner decided to give $5,000 to the shareholders as dividends. Retained earnings for the month of July were $6,000. So, the retained earnings for the month of August will be:
$6,000 + $12,000 - $5,000 = $13,000
So, the retained earnings of the company for the month of August will be $13,000.
Statement of Retained Earnings
The statement of retained earnings basically provides the information regarding retained earnings changes of the company during the particular accounting period. You are required to follow some important steps that are needed to set up retained earnings statement. The structure of the statement of retained earnings is like an equation that contains the beginning balance, net income, etc. Also, you have to make necessary adjustments to the statement. The online accounting software will calculate the retained earnings when it generates a statement of retained earnings, balance sheet, and other financial statements of your business.
How To Prepare a Statement of Retained Earnings?
You have to carefully follow the steps that are mentioned below to prepare a statement of retained earnings:
- First, you need to get the beginning or opening balance of your business.
- The beginning balance is the balance of the previous year’s retained earnings that is mentioned in the balance sheet.
- Suppose, the previous year’s retained earnings balance was $1,50,000, then the beginning balance will be recorded as $1,50,000.
- After that, you have to add the net income of the current accounting year. Assume that the company’s net income is $75,000.
- Now, you’re required to add the beginning balance and net income. So, it will become $1,50,000 + $75,000 = $2,25,000.
- Remember, if there is a net loss instead of net income, then you are required to deduct the amount. The calculation will end up like this, $1,50,000 - $75,000 = $75,000.
- After that, you need to deduct the amount of the dividend. Let’s say the dividend is $35,000. So, it will become, $1,50,000 + $75,000 - $35,000 = $1, 90, 000.
- So, the ending balance of the retained earnings statement will be $1,90,000.
Keeping a record of your business’s financial health is an important aspect of running your business smoothly. The above blog has covered the maximum possible information regarding the right method to calculate retained earnings. Carefully follow every step to maintain your retained earnings that will result in smooth business operations.
Created on Feb 18th 2021 01:56. Viewed 112 times.
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