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The retained earnings formula is ending retained earnings = beginning retained earnings + net income (or − net loss) − dividends or owner distributions. Retained earnings is the cumulative profit a business has kept since it started, reported in the equity section of the balance sheet, and when the balance falls below zero the same line is called an accumulated deficit. It is not cash and not revenue: it is the running total of profit you chose to leave in the business.
Key takeaways:
Save this cheat sheet: the formula and key terms in one image.
Retained earnings are the total profit your business has earned since day one and kept inside the company rather than paying it out to owners. The word "retained" is the whole idea: it is the profit you held onto.
Picture every year your business has operated. Some years you made money, some years you might have lost it. Add up all that net income and subtract everything you have ever paid out to owners as dividends or draws. The number left over is your retained earnings. It is not one year's result; it is the running total since the business started. At Anna Money, where we worked with more than 60,000 small businesses, retained earnings was the line owners understood the least and the line that told the truest story about their business.
That kept profit does not disappear. It funds the business: it buys equipment, covers payroll during slow months, builds a cash cushion, or pays down debt. Retained earnings is the accounting record of profit you reinvested instead of taking home, and it lives in the equity section of your balance sheet.
The retained earnings formula has four parts:
Ending retained earnings = beginning retained earnings + net income (or − net loss) − dividends or owner draws
Each piece in plain terms:
That is the entire mechanic. Profit pushes the number up, money paid to owners pushes it down, and the balance rolls forward period after period. Financial statements present this roll-forward as a statement of retained earnings, and Form 1120 repeats it line by line on Schedule M-2, covered in the tax-return section below.
Beginning retained earnings is the ending retained earnings from your previous period: open the prior period's balance sheet and copy the retained earnings line from the equity section. A brand-new business starts at $0.
If you do not have last period's balance sheet, you can back into the number by rearranging the formula:
Beginning retained earnings = ending retained earnings − net income + dividends or draws
Here is that calculation worked with real figures:
| Known figure (from this year's records) | Amount |
|---|---|
| Ending retained earnings, December 31 | $40,000 |
| Net income for the year | $72,000 |
| Owner draws taken during the year | $50,000 |
| Beginning retained earnings, January 1 | $40,000 − $72,000 + $50,000 = $18,000 |
In bookkeeping software, retained earnings is a special account in your chart of accounts: at year-end close, the software sweeps net income into it automatically, so the beginning balance rolls forward without a manual entry. If the software's figure disagrees with your own records, look for prior-year adjustments posted after the books closed.
Retained earnings can be backed out of a single balance sheet, with no income history at all: retained earnings = total assets − total liabilities − contributed capital. Contributed capital is the money owners put in: common stock and additional paid-in capital for a corporation, member or owner contributions for an LLC. Whatever equity remains after that is profit the business kept (or, if negative, lost).
| Balance sheet line | Amount |
|---|---|
| Total assets | $62,000 |
| Minus total liabilities | −$27,000 |
| Equals total equity | $35,000 |
| Minus owner contributions | −$25,000 |
| Equals retained earnings | $10,000 |
That $10,000 matches the Year 3 result in the example below. A corporation with treasury stock or other equity adjustments has to account for those lines too before reading the remainder as retained earnings.
Ending retained earnings for a period equals beginning retained earnings plus net income (or minus a net loss), minus dividends or owner draws. Numbers make it concrete. Meet Dana, who runs a one-person design studio as an LLC and started fresh, so her Year 1 beginning balance is zero.
Year 1. The studio earns net income of $48,000 and Dana takes $30,000 in owner draws to pay herself: $0 + $48,000 − $30,000 = $18,000 ending retained earnings.
Year 2. Business grows. Net income is $72,000 and Dana draws $50,000: $18,000 + $72,000 − $50,000 = $40,000 ending retained earnings.
Year 3. A slow year: a big client leaves and Dana invests in new software. The studio posts a net loss of $10,000, and she still draws $20,000 to live on: $40,000 − $10,000 − $20,000 = $10,000 ending retained earnings.
Here are the same three years side by side:
| Year | Beginning RE | Net income | Owner draws | Ending RE |
|---|---|---|---|---|
| 1 | $0 | $48,000 | $30,000 | $18,000 |
| 2 | $18,000 | $72,000 | $50,000 | $40,000 |
| 3 | $40,000 | −$10,000 | $20,000 | $10,000 |
Notice the loss year didn't wipe Dana out: the profit she had banked in earlier years absorbed it. That cushion is exactly what retained earnings is for. It also shows how draws and losses compound. Take out more than you earn, and the number falls even when you would rather it climb.
Retained earnings lives in the equity section of your balance sheet, the third block after assets and liabilities. Equity is what is left for the owner once you subtract what the business owes from what it owns, and retained earnings is one of the main lines inside that block. Like other equity accounts, retained earnings carries a normal credit balance, so a debit balance in the account means an accumulated deficit.
A simple equity section for an LLC looks like this:
| Equity account | Amount |
|---|---|
| Owner contributions | $25,000 |
| Retained earnings | $10,000 |
| Total equity | $35,000 |
The whole balance sheet obeys one rule: assets equal liabilities plus equity. Because retained earnings is part of equity, it has to fit inside that equation. When your business earns a profit, retained earnings goes up, and an asset (usually cash) rises or a liability falls to keep both sides equal. This is the double-entry logic behind every report; if the mechanics feel fuzzy, our guide on debits and credits explained walks through how each entry keeps the sheet balanced.
Retained earnings also connects your two main reports. Your profit-and-loss statement produces net income for the period, and that net income flows into retained earnings on the balance sheet. The P&L tells you how you performed; retained earnings remembers it. That link is why accountants call retained earnings the bridge between the income statement and the balance sheet.
Yes. An accumulated deficit is retained earnings with a negative balance: the same balance-sheet line, relabeled once lifetime losses and owner payouts exceed lifetime profits. UK and international filings often call the identical figure "accumulated losses" or "retained losses." There is no separate calculation; the ordinary retained earnings formula simply produces a number below zero.
| Retained earnings | Accumulated deficit | |
|---|---|---|
| Balance | Positive | Negative |
| What it means | Lifetime profits kept exceed losses and payouts | Lifetime losses plus payouts exceed profits |
| Other labels | Retained profits | Accumulated losses, retained losses |
| Formula | Beginning RE + net income − payouts | Same formula; the result is below zero |
The accumulated deficit formula is: beginning balance + net income (or − net loss) − payouts, with the result carried as a negative equity line. Take a startup coffee roaster's first three years:
| Year | Beginning balance | Net income (loss) | Owner payouts | Ending balance |
|---|---|---|---|---|
| 1 | $0 | −$15,000 | $0 | −$15,000 |
| 2 | −$15,000 | −$5,000 | $0 | −$20,000 |
| 3 | −$20,000 | +$12,000 | $0 | −$8,000 |
After Year 3 the roaster still carries an accumulated deficit of $8,000, but the trend has reversed: one more profitable year erases it. That pattern matters more than the sign.
A deficit is common and not automatically alarming. A young business often runs losses for a year or two before turning the corner; that is an accumulated deficit by design. Lenders read it as a signal to look closer at why. A persistent and growing deficit, year after year with no path to profit, is the real warning sign, not a single negative year.
There is also a practical limit for owners: you generally should not keep drawing money out of a business that is accumulating a deficit, because you are pulling out capital the business does not have to give. If you are an LLC owner figuring out how much you can reasonably take, our guide on how to pay yourself from an LLC covers the safe ways to do it.
Retained earnings turn into an accumulated deficit when a period's net loss plus owner payouts is larger than the balance the business started the period with. Continue Dana's design studio from the three-year example above: she enters Year 4 with $10,000 of retained earnings.
| Year | Beginning balance | Net income (loss) | Owner draws | Ending balance |
|---|---|---|---|---|
| 4 | $10,000 | −$4,000 | $12,000 | −$6,000 |
| 5 | −$6,000 | $15,000 | $4,000 | $5,000 |
The Year 4 loss alone would have left $6,000 of retained earnings; the $12,000 of draws took the balance to −$6,000, an accumulated deficit. In Year 5, profit above draws erases the deficit, and the line goes back to being called retained earnings.
An accumulated deficit stays in the equity section, on the retained earnings line, shown as a negative number in parentheses and often labeled "Accumulated deficit" or "Retained earnings (deficit)." It reduces total equity and never moves to liabilities. Dana's equity section at the end of Year 4:
| Equity account | Amount |
|---|---|
| Owner contributions | $25,000 |
| Accumulated deficit | ($6,000) |
| Total equity | $19,000 |
If the deficit ever grows larger than the capital the owners put in, total equity turns negative: the business owes more than it owns.
Two mix-ups cause most of the confusion. Clear them up and the whole concept clicks.
Retained earnings is not cash. This is the big one. Retained earnings of $50,000 does not mean $50,000 is sitting in your bank account waiting to be spent. The profit you retained may already be tied up: spent on a $30,000 piece of equipment, locked in inventory, or owed to you by customers who have not paid yet. Retained earnings is an equity figure that tracks accumulated profit; cash is a separate asset line. A business can have healthy retained earnings and an empty checking account at the same time, and vice versa. The report that explains where the actual money went is the cash flow statement.
Retained earnings is not revenue. Revenue is the top line: total money your business brought in over a period, before any costs. Retained earnings is far downstream of that. Revenue becomes net income only after every expense comes out, and net income only becomes retained earnings after owner payouts are subtracted and the result is added to all prior years.
Here is the relationship in one table:
| Term | What it measures | Time frame | Where it lives |
|---|---|---|---|
| Revenue | Total money earned, before costs | One period | Top of the P&L |
| Net income | Profit after all expenses | One period | Bottom of the P&L |
| Retained earnings | Cumulative kept profit | Entire life of business | Equity on the balance sheet |
| Cash | Money in the bank right now | A single moment | Assets on the balance sheet |
Keeping these four straight is most of what separates an owner who reads their books from one who guesses.
How retained earnings shows up depends on your entity type. The math is the same; the labels and tax treatment differ.
Sole proprietorships and single-member LLCs. Strictly speaking, a sole prop does not keep a separate "retained earnings" account; its equity usually lives in a single owner's capital account that blends contributions, draws, and accumulated profit. Many bookkeeping setups still track a retained-earnings line for clarity, but the spirit is the same: profit you did not draw out stays as your equity. You pay tax on the business's profit on your personal return whether you draw it or not, so leaving money in the business does not change your tax bill for that year. Money you take out is an owner draw, not a paycheck and not a taxable dividend.
Multi-member LLCs and partnerships. Equity is split into a capital account per owner. Each member's share of profit raises their capital; distributions lower it. The retained-earnings concept applies across the whole entity, then gets allocated among members by ownership.
C corporations. A C corp keeps a formal retained-earnings account, separate from paid-in capital. Profit the corporation keeps stays here; profit paid to shareholders is a dividend, which reduces retained earnings and is generally taxable to the shareholder. If you receive corporate dividends, our dividend tax calculator helps you estimate what you'll owe.
S corporations. An S corp tracks retained earnings on its balance sheet, but for tax purposes it also maintains a separate ledger called the Accumulated Adjustments Account (AAA) on Schedule M-2 of Form 1120-S. The AAA tracks already-taxed income to determine whether a distribution is tax-free or taxable. Per the IRS, AAA rises with the corporation's income and falls with deductions, losses, and distributions. It is a tax record that runs alongside book retained earnings, not a replacement for it, and the two often differ. The AAA starts at zero on the first day of the corporation's first S corporation year, and the IRS instructions say distributions cannot reduce it below zero; only losses can push the AAA negative.
The takeaway: every entity accumulates kept profit, but a sole prop calls the money it takes out a draw, while a corporation calls it a dividend — and that single distinction drives different tax treatment.
Retained earnings can be zero for a sole proprietorship or a single-member LLC taxed as one: many bookkeepers close each year's net income and owner draws into the owner's capital account, which leaves retained earnings at zero when the new year starts. A multi-member LLC taxed as a partnership closes them into each member's capital account instead. A corporation's retained earnings are never zeroed out this way; they carry forward until losses or dividends reduce them.
Bookkeeping software usually sweeps each year's net income into a Retained Earnings account automatically, whatever the entity type. For a sole proprietorship, the year-end closing entry then moves that balance, and the year's owner draws, into owner's capital. That matches the textbook model, in which a sole proprietorship keeps a single equity account that accumulates the owner's investments and net income and absorbs distributions.
Among the returns small businesses file, retained earnings appear only on the corporate ones: Form 1120 reports them on Schedule L, lines 24 and 25, and rolls line 25 forward on Schedule M-2, while Form 1120-S reports them on Schedule L, line 24. A partnership return reports partners' capital accounts instead, and Schedule C has no balance sheet at all.
| Return (2025 forms) | Where retained earnings go | When the balance-sheet schedules can be skipped |
|---|---|---|
| Form 1120 (C corporation) | Schedule L, line 24 (retained earnings, appropriated) and line 25 (unappropriated); Schedule M-2 reconciles line 25 | Schedule K, question 13: total receipts and year-end total assets both under $250,000 means Schedules L, M-1, and M-2 are not required |
| Form 1120-S (S corporation) | Schedule L, line 24 (retained earnings); Schedule M-2 tracks the accumulated adjustments account (AAA), not book retained earnings | Schedule B, question 11: both under $250,000 means Schedules L and M-1 are not required; Schedule M-2 still is |
| Form 1065 (partnership or multi-member LLC) | No retained earnings line: Schedule L, line 21 (partners' capital accounts), analyzed on Schedule M-2 | Schedule B, question 4: receipts under $250,000, assets under $1 million, K-1s furnished on time, and no Schedule M-3 means Schedules L, M-1, and M-2 are not required |
| Schedule C (sole proprietor or single-member LLC) | No balance sheet: Parts I–V cover income, expenses, cost of goods sold, vehicle information, and other expenses | Not applicable |
For the partnership version of these schedules, our Form 1065 instructions guide goes line by line.
Schedule M-2 of Form 1120, "Analysis of Unappropriated Retained Earnings per Books," lays out the ending retained earnings formula as form lines: the balance at the beginning of the year (line 1), plus net income per books (line 2) and other increases (line 3), minus distributions (line 5: 5a cash, 5b stock, 5c property) and other decreases (line 6), equals the balance at the end of the year (line 8). Line 8 is the year-end figure on Schedule L, line 25.
A C corporation that starts the year with $120,000 of unappropriated retained earnings, books $45,000 of net income, and pays $20,000 of cash dividends fills in:
| Schedule M-2 line | Amount |
|---|---|
| 1. Balance at beginning of year | $120,000 |
| 2. Net income (loss) per books | $45,000 |
| 4. Add lines 1, 2, and 3 | $165,000 |
| 5a. Distributions: cash | $20,000 |
| 7. Add lines 5 and 6 | $20,000 |
| 8. Balance at end of year (line 4 less line 7) | $145,000 |
Yes. A C corporation that accumulates earnings beyond the reasonable needs of the business can owe the accumulated earnings tax, 20% of accumulated taxable income under IRC §531. The minimum accumulated earnings credit shelters the first $250,000 of accumulated earnings and profits, or $150,000 for a corporation whose principal function is services in health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting (IRC §535(c)). Accumulated earnings and profits is a tax measure that often differs from the retained earnings on the balance sheet.
Retained earnings is not an academic line. Three audiences read it closely.
Lenders. When you apply for a business loan or line of credit, the bank pulls your balance sheet and looks at retained earnings to judge whether the business has been profitable and is building equity. Growing retained earnings says the business funds itself and can absorb a rough patch. A deficit invites questions. The line is a quick read on financial track record.
Buyers and investors. Anyone valuing your business studies retained earnings as a measure of reinvested profit and staying power. A company that has steadily retained earnings has demonstrated it can grow on its own profits rather than constant outside cash. If you are sizing up what a business is worth, our business valuation calculator factors in earnings, and retained earnings is part of that equity picture.
You. The most important reader is the owner. Retained earnings tells you how much profit you have actually banked into the business versus pulled out. It frames the real question behind every draw or dividend: should this profit go to me now, or stay and fund the next stage of growth? Reinvested earnings are the cheapest growth capital there is: no interest, no new investors, no strings.
Treating retained earnings as a spending account. The number is not a cash reserve you can withdraw on a whim. Check your actual cash balance before any distribution; the two can be wildly different.
Confusing this year's profit with retained earnings. Net income is one period. Retained earnings is the lifetime running total. A great year does not reset the number; it adds to whatever came before, deficits included.
Forgetting to subtract owner draws. Plenty of owners add up net income year over year and call it retained earnings, ignoring everything they took out. Draws and dividends always come out of the formula. Skip them and your equity is overstated.
Panicking over a single negative year. One year of accumulated deficit, especially early on, is normal. The pattern over time matters far more than any one figure.
Letting book and tax records drift. For S corps especially, retained earnings on the books and the AAA on Schedule M-2 are different numbers that move for different reasons. Keep both, and do not assume one equals the other.
Retained earnings is only as accurate as the net income feeding it, and net income is only as accurate as the categorization underneath. Jupid is an AI accountant that lives in WhatsApp and iMessage: connect your bank account and it auto-categorizes every transaction at 95.9% accuracy, so the profit that rolls into your equity is right. Between draws, ask in plain language — "what's my net income this quarter?" or "how much have I taken out this year?" — and get an answer in seconds, no report-building required. Try Jupid.
This guide is for general educational purposes and does not constitute tax, legal, or accounting advice. The treatment of retained earnings, owner draws, and distributions varies by entity type and situation. Consult a qualified accountant or tax professional before relying on these figures for loans, valuation, or tax filing.
CEO & Co-Founder
Fintech CEO with 10+ years building accounting and financial technology products. Previously co-founded and scaled an AI-powered accounting platform to $30M revenue and 100K+ business users, achieving 30,000 customers per accountant through automation — recognized by CNBC as a top fintech company. Holds a Master's in Management Information Systems. At Jupid, he leads the development of AI-native bookkeeping, tax, and compliance tools designed for freelancers and small business owners.
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