Retained earnings represents the capital amount a company has leftover at the end of a fiscal year. The company must decide whether to reinvest in its core business activities, pay liabilities or distribute profits to shareholders. As an investor, evaluating retained earnings from year to year can help you understand a company's track record and how it uses its profits to generate a return.
1. Calculate total revenues. Look on the company's income statement for the accounting period and add the total of all revenue accounts listed. Revenues include sales revenue, interest revenue and others, depending on the company. For example, assume all of a company's revenue accounts totaled $88,000.
2. Determine the company's total expenses. Look on the Income Statement and add all expense accounts listed, such as selling expense and all general and administrative expenses. This includes salaries expense, rent expense and utilities. For this example, we'll assume the company's expenses totaled $33,000.
3. Subtract the company's total expenses from its total revenues. The result is the company's net income. In the previous example, subtracting $33,000 from $88,000 equals a net income of $55,000. If expenses exceed revenues, you have a loss and the result would be a negative number.
4. Subtract the dividends paid throughout the year from the company's net income. The result is the amount you add to the company's beginning retained earnings. For instance, assume the company in the previous example paid $13,000 in dividends to shareholders. Subtracting $13,000 from $55,000 equals $42,000, the retained earnings for this year that is added to the retained earnings ledger account. If retained earnings for the year is a loss, you subtract it from the beginning retained earnings.
- Sole proprietorships will not have dividends to subtract from its net income.
- Add the retained earnings for the year to the company's beginning retained earnings to get the total of the company's accumulated profits over time.
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