Retained Earnings

Retained earnings represent the total net profits your business has accumulated over its entire lifetime, minus any distributions (dividends or owner draws) that have been paid out. Think of it as the running score of how much profit the business has kept for itself rather than giving to its owners.

The formula is: Retained Earnings = Previous Retained Earnings + Net Income - Distributions. Each year, your net profit (or loss) gets added to the retained earnings balance, and any owner draws or dividends get subtracted. If your business earned $50,000 in net profit this year and you drew $30,000 as salary/distributions, $20,000 gets added to retained earnings.

Retained earnings appear in the equity section of your balance sheet. They're not a separate bank account or pile of cash — they represent the cumulative profits that have been reinvested in the business in the form of assets (cash, equipment, inventory, etc.) or used to pay down liabilities. A business with $200,000 in retained earnings doesn't necessarily have $200,000 in the bank — that money has been working inside the business in various forms.

Retained earnings are the primary way small businesses fund their own growth without taking on debt or bringing in outside investors. Every dollar of retained earnings is a dollar the business can use to buy equipment, hire employees, expand to new locations, or build a cash reserve for tough times. A healthy and growing retained earnings balance signals a profitable, well-managed business. Lenders look at retained earnings as evidence of financial stability and the owner's commitment to reinvesting in the business. Negative retained earnings (an accumulated deficit) signal that the business has lost more money than it's made over its lifetime — a significant red flag for lenders and potential buyers.