There are so many financial factors involved in running a small business, and learning how to calculate your company's retained earnings is one example. Retained earnings refer to the surplus net income left to your business once all appropriate dividends have been paid to shareholders. This portion of your company's profits can then be funneled into fixed assets, used to pay off outstanding loans, or invested in working capital.

Skynova's comprehensive accounting software can save you time and effort when calculating your business's retained earnings. It can also help you easily organize other aspects of your company's financial landscape, such as its income statement or form of dividends. This article will highlight the importance of retained earnings and review best practices for calculating them accurately.

What Are Retained Earnings on a Balance Sheet?

The first item to understand about retained earnings is that they don't include dividends. Dividend payments are nonrefundable and, once issued, leave your company's accounting books for good. Every other way that the net profits of your business can be used qualify as "retained earnings." Retained earnings represent several classifications of funding opportunities and investments.

Sometimes, retained earnings are called "earnings surplus" because they represent the cumulative net profits of your business that can be held as reserve money. As a small business owner or freelancer, you can choose to reinvest that reserve into various other company needs of your choice. If expressed in the form of a percentage of your business's total earnings, retained earnings are called "retention ratio." Your retained earnings will be reported on your balance sheet under the shareholder's equity section at the end of each accounting period.

How Do You Calculate Retained Earnings?

Retained earnings should be viewed as a running scoreboard of your company's profits since the day it was formally founded. As such, you should view retained earnings as an ever-changing figure, as this number will go up each time your company earns a profit and down each time you pay out dividends.

Fortunately, the standard retained earnings formula is pretty easy to follow:

Retained Earnings = Beginning Period Retained Earnings + Net Income or Loss – Cash Dividends – Stock Dividends

Essentially, you find your retained earnings by adding together your beginning holdings and your net income or loss for the accounting period, and then you subtract all dividends paid out (both cash and stock). If you don't feel confident tallying this important number on your own, look to Skynova's accounting software to help you quickly and accurately calculate retained earnings. The following steps will also put you on the right path to properly calculating retained earnings.

Step 1: Determine Beginning Period Retained Earnings

As each accounting period comes to a close for your business, retained earnings will be reported on your balance sheet. This retained earnings ending balance will represent the accumulated income your business generated the previous year and the current year's income minus all dividends paid to shareholders.

This means that as the new accounting cycle begins, your retained earnings ending balance from the prior year now becomes your retained earnings beginning balance or "beginning retained earnings." Crucial to note here is that the retained earnings balance may not always be a positive number. This can be so when net losses for a current period exceed the beginning balance or when major distributions of dividends have caused a similar deficit.

Step 2: Calculate Net Income or Net Loss

Net income is what your company has left once you have paid all of your expenses. This means taking whatever sales revenue you have and subtracting interest expenses, amortization, depreciation, taxes, the cost of goods sold (COGS), and all other liabilities or operating expenses.

However, note that net loss only refers to times when the expenses of your business may exceed its income. Net loss is tallied by adding any and all financial outlays for the accounting period in question. Interestingly, if you are experiencing a net loss period, it is your retained earnings account that can help you stay afloat.

Step 3: Calculate Cash Dividends

Cash dividends are payments made in cash to your shareholders against current earnings or accumulated profits. For instance, let's say your boutique engraving shop has done remarkably well in December due to all of the holiday orders. You post a net income that month of $10,000 and want to share $1,000 each with your business's stockholders (e.g., your husband and daughter) via a dividend payout. The distribution of $2,000 in cash to both your husband and your daughter will represent your cash dividends for this accounting period.

Remember that how dividends impact your retained earnings will vary depending on your beginning balance and forthcoming income. Keeping up with your company's statement of retained earnings lets you know when reinvestment is wise and when your retained earnings balance might best go toward other needed expenditures.

Step 4: Determine Stock Dividends

Stock dividends are payments that one makes to shareholders in the form of shares rather than cash. It is common for businesses to issue stock dividends when liquid cash might not be as readily available or when the amount of dividends could dip total assets too low for comfort. It's up to the business's board of directors (even if you are the only person on the board) to determine when a stock dividend should be issued and in what amount. Stock dividends increase the shares that a company will have outstanding, but the stock price must decrease in accordance with that change.

A few extra steps are involved when it comes to calculating stock dividends on your company's balance sheet, and the first of which entails finding the fair market value of the shares you will offer. When figuring out retained earnings as they relate to stock dividends, the equation appears as follows:

Retained Earnings = Current Retained Earnings + Net Income - (Number of Shares x Fair Market Value of Each Share)

Let the monthly financial health of your company, your cash outflow, and total assets help you decide when stock options might be the best option for a specific period.

Step 5: Calculate Your Retained Earnings

With the four previous steps, you've learned how to figure each segment of the retained earnings calculation for your balance sheet. Now that you have those steps in order, you are ready to determine your actual retained earnings. Remember that your shareholder's equity and working capital sections of the balance sheet are totally different from your retained earnings.

Also, bear in mind that you will want to use the retained earnings figure you come up with to determine what to do with the surplus capital (e.g., invest, make expansions, or pay dividends). Most companies calculate retained earnings at least once per month as a standard form of bookkeeping.

How Do You Calculate End-of-Period Retained Earnings?

When you come to the end of your annual accounting period, you will need to conduct one final retained earnings tally. This is called your end-of-period retained earnings figure. The formula for calculating this last sum is:

Dividends = Beginning Retained Earnings – Ending Retained Earnings + Net Income (- Loss)

Let Skynova Help You Manage Your Small Business Financial Statements

Calculating retained earnings for your small business doesn't have to be frightening or confusing when you look to Skynova to streamline and organize your business accounting. Our accounting software was made with small businesses in mind and can keep accurate records of income, expenses, sales tax, and payments. Meanwhile, our other software products can simplify all stages of running your business, whether you need to make professional-looking invoices or provide estimates to potential customers.

Skynova can streamline the process of small business accounting so you can focus on growing your company and its retained earnings. Check out Skynova today for everything from help with invoices and online payments to processing credit notes or setting up billing for subscriptions.