When you’re in business, profits are your bread and butter. If profits are good, you should have some retained earnings to work with. If profits aren’t so good, then you’ll be thankful you have those retained earnings to fall back on.
But how do you figure out how to calculate retained earnings anyway? Well, heads up—it’s going to mean some math. But you don’t have to get out your fancy calculator. We’ll show you how to use a slick retained earnings formula to get to the bottom of it (it’s not that bad, promise).
What Are Retained Earnings?
If you’re in business, you’ve got to pay out profits to your shareholders. The amount of money you have left over as net income after doing that is your retained earnings—aka money you get to keep to invest back into the business. Think of retained earnings as money your business has made over time. When the business makes money, the retained earnings go up. And when you spend some of those profits, retained earnings go down.
How to Calculate Retained Earnings
So, now that you know what retained earnings are, let’s talk about how to calculate them. When it all comes down to it, a not-so-crazy formula can help you out here.
Retained Earnings Formula
Remember how you told your 11th grade Algebra 2 teacher that when you grew up, you were never going to use this math stuff. Well, guess what? You’re about to use it. Get ready to put on your thinking cap, because here’s the formula to figure out retained earnings:
RE = BP + Net Income (or Loss) – C – S
RE is retained earnings
BP is beginning period of retained earnings
C is cash dividends
S is stock dividends
Sheesh. All right, let’s try and make some sense out of that formula. You can calculate your retained earnings by adding up the current retained earnings plus your profit (or loss), then subtracting your cash and stock dividends. Yeah—it’s a mouthful. But all you’re really doing here is adding up your extra money you’re carrying over and new gains (or losses). Then you just subtract the other things you have to pay out. Sounds a little more like plain talk now, right?
How to Save Retained Earnings
Let’s walk you through how to hang on to some retained earnings while keeping the other parts of the business moving and grooving.
Now, you can do a few different things with your retained earnings from your business. You can keep on hiring, amp up production, dive into a new product line, or—last but not least—use them to pay off your business debt. Can you guess which one is most important? Yep, you guessed it—paying off that business debt.
After you pull out enough to live on for yourself (just a basic living wage—nothing crazy), whatever net profit you have left should go to paying off your business debt. Business debt is different than personal debt in how you attack it. When you’re paying off personal debt, you save up $1,000 for emergencies in Baby Step 1, then you go crazy paying off your debt in Baby Step 2. But when it comes to business debt, you need to pay yourself a living wage and build some retained earnings so you can stay afloat. Your business is what’s making you money—you have to keep that puppy open.
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So, go ahead and factor in how much retained earnings you want to save. You could set aside 10–15% in retained earnings, but don’t go above 20%. You want to have at least 80% left over to dump onto the debt and really attack it. Make sure you get in the habit of saving and always putting aside retained earnings as the business continues to grow.
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