At ProfitBooks, we often see business owners staring at their balance sheet with one recurring question: “What’s this retained earnings number, and why doesn’t it match my bank balance?”
I’ll be honest—retained earnings trips up more founders than almost any other accounting line item.
Not because the math is hard, but because the concept sits at this weird intersection of profit, cash flow, and equity that most business guides gloss over.
Reader Promise: By the end of this guide, you’ll understand exactly what retained earnings is, how to calculate it correctly, and why it matters for decisions you’re making right now.
What Is Retained Earnings?
Retained earnings is the profit your business keeps over time after paying dividends or owner withdrawals.
It builds up year after year and shows how much profit you’ve reinvested back into the business.
Think of it as your company’s financial memory. Every rupee of profit that didn’t get distributed to owners stays in the business—that’s retained earnings.
It’s not sitting in your bank account as cash (more on that confusion in a minute), but it represents the cumulative profit that’s funding your operations, inventory, or growth.
You’ll find retained earnings on your Balance Sheet under the Equity section. It’s one of those numbers that quietly grows in the background when things are going well, or shrinks when losses pile up.
The Retained Earnings Formula
Here’s the calculation you need:
Let me break down each piece:
- Beginning retained earnings: Last year’s closing balance. If you’re calculating for FY 2025-26, this is what showed up on your balance sheet at the end of FY 2024-25.
- Net profit (or net loss): Your current year’s final result from the Profit & Loss statement. This is revenue minus all expenses—not your revenue alone.
- Dividends (or withdrawals): Money you took out from profits. For private companies and sole proprietors, this includes owner distributions. For corporations, it’s formal dividend payments to shareholders.
The formula is static—hasn’t changed in decades, and it won’t. But the way we track these numbers has shifted. Today, most businesses track net profit and retained earnings in real-time through accounting platforms rather than waiting for year-end spreadsheets.
Step-by-Step: How to Calculate Retained Earnings
Let’s walk through the actual process.
Step 1: Identify Beginning Retained Earnings
Pull your prior period’s balance sheet. Look under the Equity section for a line labeled “Retained Earnings.” That’s your starting point.
- If you’re a new business: Your beginning retained earnings is ₹0. You’re starting fresh.
- If you’ve been operating: This number carries forward automatically.
In ProfitBooks, when you check your Balance Sheet from the previous year, the retained earnings figure is already there under equity. No manual hunting required.
The friction point: Sole proprietors sometimes confuse retained earnings with total equity. Retained earnings is just one component of equity—it’s the accumulated profit portion, not your initial capital contribution.
Step 2: Add Net Profit (or Subtract Net Loss)
Now grab your current year’s Profit & Loss statement. The bottom line—net income or net loss—is what you need.
- Net profit: Add it to beginning retained earnings.
- Net loss: Subtract it. Yes, retained earnings can go negative.
Startups often show negative retained earnings (called an accumulated deficit) during their growth phase. That’s not a crisis—it just means you’ve invested heavily and losses have outpaced profits so far.
Visual checkpoint: Your P&L should clearly show “Net Profit” or “Net Loss” at the bottom. If you’re looking at gross profit or operating income, you haven’t scrolled far enough.
Step 3: Subtract Dividends or Withdrawals
This is where confusion peaks.
If you paid formal dividends (common in corporations), subtract the total amount distributed to shareholders during the year. If you’re a sole proprietor or partnership, owner draws aren’t technically dividends, but they reduce retained earnings all the same.
The accounting treatment differs slightly, but the economic effect is identical—money left the business.
Common mistake: Business owners forget to track withdrawals separately from expenses. If you paid yourself ₹50,000 as an owner draw, that’s not a salary expense—it’s a reduction of equity. Make sure it’s logged correctly, or your retained earnings calculation will be inflated.
Step 4: Arrive at Closing Retained Earnings
Add it all up. Your ending retained earnings becomes next year’s beginning retained earnings. The cycle continues.
When you check your Balance Sheet in ProfitBooks, this updated retained earnings figure appears automatically under equity. No formula gymnastics. No spreadsheet links breaking because you renamed a tab.
Real-World Examples
Example 1: Profit Without Dividends
Let’s say you run a subscription-based design agency.
- Beginning retained earnings: ₹2,00,000 (carried over from last year)
- Net profit for the year: ₹3,50,000 (strong year, recurring revenue came through)
- Dividends paid: ₹0 (you reinvested everything)
Calculation:
₹2,00,000 + ₹3,50,000 − ₹0 = ₹5,50,000
Your closing retained earnings is ₹5,50,000. This means over the life of your business, you’ve accumulated ₹5.5 lakh in profit that’s still working inside the company—funding payroll, software subscriptions, or your emergency fund.
Example 2: Profit With Dividends
Now let’s say you’re running a small manufacturing unit.
- Beginning retained earnings: ₹8,00,000
- Net profit for the year: ₹4,50,000
- Dividends paid: ₹1,50,000 (you distributed some profit to partners)
Calculation:
₹8,00,000 + ₹4,50,000 − ₹1,50,000 = ₹11,00,000
Your closing retained earnings is ₹11 lakh. Even after taking out ₹1.5 lakh, you’ve still grown your cumulative profit reserve by ₹3 lakh this year.
What this means: You have a healthy cushion for expansion, and investors or lenders will see consistent profitability when they review your equity roll-forward.
If you don’t want to calculate retained earnings manually every time, ProfitBooks makes it simple. Your Balance Sheet updates automatically, so you can track retained earnings anytime without spreadsheets or confusion.
What Retained Earnings Is NOT
This is where most confusion happens, so let’s clear it up.
Retained Earnings ≠ Cash in Bank
Retained earnings is a balance sheet number, not your bank balance. You can have ₹5,00,000 in retained earnings and only ₹50,000 in your bank account. Why?
Because that profit has been reinvested—into inventory, equipment, unpaid invoices (accounts receivable), or paying down debt.
A bakery owner I worked with had ₹10 lakh retained earnings but panicked when cash flow tightened. Turns out, most of that profit was tied up in flour inventory and a new oven. The profit existed, but liquidity didn’t.
Retained Earnings ≠ Revenue
Revenue is the total sales you made. Retained earnings is the accumulated profit after expenses, over multiple years.
If you made ₹20 lakh in revenue but spent ₹18 lakh on costs, your net profit is ₹2 lakh. Only that ₹2 lakh (minus any withdrawals) gets added to retained earnings.
Mini-example: You can have ₹5 lakh retained earnings but still face cash issues if customers haven’t paid. Revenue recognition and cash collection don’t always align, especially if you’re on accrual accounting.
Where Retained Earnings Appears in Your Reports
Retained earnings sits on the Balance Sheet under the Equity section. It typically looks like this:
– Owner’s Capital: ₹5,00,000
– Retained Earnings: ₹3,50,000
– Total Equity: ₹8,50,000
Some accounting tools also generate a Statement of Retained Earnings—a standalone report showing the beginning balance, additions (net income), subtractions (dividends), and ending balance. It’s essentially the formula in report format.
Why Retained Earnings Matters
Here’s where this number moves from “accounting trivia” to “business strategy.”
1. Reinvesting Into Growth
Retained earnings funds expansion without loans. If you want to hire, open a second location, or upgrade equipment, a healthy retained earnings balance means you can self-fund instead of borrowing.
2. Building a Financial Cushion
Negative cash flow months happen. Retained earnings acts as your business’s safety net. If revenue dips, you’re not immediately scrambling for emergency credit.
3. Gaining Investor Confidence
Investors and lenders scrutinize retained earnings during due diligence. Consistent growth signals profitability and discipline. Negative retained earnings (accumulated deficit) isn’t a dealbreaker for startups, but you need to explain the growth strategy behind it.
4. Showing Long-Term Profitability
A single profitable year is nice. Five years of growing retained earnings proves your business model works. It’s the difference between a fluke and a trend. Retained earnings shows how strong your business has become over time. It’s one of the cleanest proxies for cumulative value creation.
Quick Reference: Retained Earnings Cheat Sheet
| Term | Meaning |
|---|---|
| Beginning retained earnings | Last year’s closing balance |
| Net profit/loss | This year’s final result from P&L |
| Dividends/withdrawals | Money taken out by owners |
| Closing retained earnings | Updated balance for this year |
Common Mistakes When Calculating Retained Earnings
1. Treating Retained Earnings as Available Cash
This is the most common error. Retained earnings is an accounting figure, not a liquidity measure. Always check your cash flow statement if you need to understand actual cash availability.
2. Using Revenue Instead of Net Profit
Revenue is the top line. Net profit is the bottom line. Only net profit affects retained earnings. If you’re plugging revenue into the formula, your number will be wildly inflated.
3. Forgetting to Subtract Dividends or Withdrawals
Owner draws, dividend payments, and distributions all reduce retained earnings. If you skip this step, you’ll overstate your equity and confuse future calculations.
4. Assuming Retained Earnings Always Increases
Growth-stage businesses often show negative retained earnings. Heavy investment, product development costs, and scaling expenses can create accumulated deficits. That’s normal—as long as you have a plan to reach profitability.
5. Ignoring Prior-Year Retained Earnings
If you’re calculating mid-growth and forget to pull the beginning balance, your entire calculation collapses. Retained earnings is cumulative by nature. Each year builds on the last.
Troubleshooting: When the Numbers Don’t Match
“My retained earnings is negative—is my business failing?”
Not necessarily. Startups and high-growth businesses frequently show negative retained earnings (accumulated deficit) because they’re investing heavily before hitting profitability. Focus on your cash runway and path to positive net income.
“Why doesn’t my software match my manual calculation?”
Run a data reconciliation. Check if your accounting tool is on accrual basis (GAAP-compliant) while you’re calculating on cash basis. Retained earnings only makes sense under accrual accounting. Also, some platforms cache data—try refreshing reports or rebuilding your dataset.
“Owner draws are inflating my retained earnings—what’s wrong?”
You’re probably logging draws as expenses instead of equity distributions. Reclassify them. Owner draws don’t run through the P&L; they directly reduce equity. If they’re hitting your expense categories, your net profit is understated and your retained earnings is overstated.
“I made a profit, but retained earnings didn’t change much. Why?”
Check your dividend or withdrawal activity. If you distributed most of your profit, the net addition to retained earnings will be small. Also verify that your beginning retained earnings was pulled correctly—errors here cascade forward.
How Modern Accounting Handles Retained Earnings
In 2026, most businesses don’t manually track retained earnings in spreadsheets. Platforms update the balance sheet automatically as you record income, expenses, and distributions.
When you run a Profit & Loss report, the net income flows directly into equity. When you log a dividend payment or owner draw, it adjusts retained earnings in real time. No formulas to maintain, no year-end surprises.
This automation matters because investor reporting and tax filing demand accuracy. One misclassified transaction can throw off your entire equity section.
Tools like ProfitBooks keep the balance sheet, P&L, and cash flow interconnected, so retained earnings stays accurate without manual intervention. If you’re still calculating retained earnings in Excel, you’re one formula error away from a reporting headache.
And when you scale—adding team members, multiple revenue streams, or investor scrutiny—manual tracking becomes a liability.
Once you understand the formula, retained earnings becomes one of the easiest numbers to track and one of the most useful too. It’s not just an accounting requirement. It’s a scorecard of how much value your business has created and kept over time.
The math is simple: start with last year’s balance, add this year’s profit, and subtract what you took out.
But the insight is powerful. Retained earnings tells you whether your business is building financial strength year after year or slowly draining it without realising.
And if you don’t want to rely on spreadsheets or manual tracking, ProfitBooks makes this effortless. Your retained earnings updates automatically through your reports, so you always have a clear picture of profit, equity, and business health whenever you need
