A retained income account, often called a retained earnings account, is a financial ledger that businesses use to track the accumulated profits set aside for reinvestment in the business. The account reflects the portion of net income the business keeps – and does not distribute as dividends to shareholders – to fund growth, pay down debt, or prepare for the future.

Below, we’ll explain what you should know about retained income accounts, including why they’re important for businesses and how to calculate that income.

What’s in this article?

• How does a retained income account appear on financial statements?
  
• What factors affect the balance in a retained income account?
  
• Why is retained income important for growth?
  
• How do businesses calculate retained income?
  
• What are common mistakes in managing retained income accounts?
  

How does a retained income account appear on financial statements?

Depending on the financial statement you’re using, retained income can appear in different ways.

On a balance sheet

The shareholders’ equity section of the balance sheet is the business’s cumulative earnings, less any dividends, alongside other equity accounts such as common stock.

It typically looks like this:

Shareholders’ Equity

• Common Shares: £50,000
  
• Retained Earnings: £120,000
  
• Total Equity: £170,000
  

This is a snapshot of what has been reinvested in the business instead of disbursed.

On a statement of retained earnings

Businesses sometimes produce a statement of retained earnings to examine this equity separately. This statement includes a short accounting of the account’s activity for a given period. It starts with the retained earnings balance at the beginning of the period, then adds net income or net loss from the income statement. Finally, it subtracts dividends paid out during the period to arrive at the ending balance, which is carried over to the balance sheet.

Here’s an example:

Statement of Retained Earnings

• Beginning Retained Earnings: £100,000
  
• Add: Net Income £40,000
  
• Less: Dividends Paid (£20,000)
  
• Ending Retained Earnings: £120,000
  

This statement helps assess the business’s profitability and how profits are being used.

On an income statement

You typically won’t see retained earnings directly on the income statement, though you will see net income. That final net income flows into the retained earnings account.

What factors affect the balance in a retained income account?

Factors such as a business’s profitability, financial strategy, and changes in ownership structure can affect retained income. Here are the biggest factors that influence retained income accounts:

Net income or net loss

If the business is profitable (i.e. has net income), retained earnings increase. If it has a net loss, they decrease. Consistent profitability helps this account grow over time.

Dividend payments

Dividends affect retained earnings. Whether a cash dividend (which lowers retained earnings and cash) or a share dividend (which shifts equity without reducing total equity), they lower the retained earnings account balance. Businesses must balance keeping shareholders happy and reinvesting earnings into the business.

Adjustments from previous periods

Sometimes, businesses need to fix mistakes or update their books to reflect new accounting rules. These adjustments can add to or subtract from retained earnings. For example:

• If revenue was missed in a previous year, that’s an increase after adjustment.

• If expenses were understated, retained earnings might decrease.

Key business decisions

Decisions about reinvesting in the business, whether to fund growth projects or buy new assets, can indirectly affect retained earnings. They influence future profitability, which eventually affects this balance.

Corporate restructuring

Mergers, acquisitions, or divestitures often move around equity, which can also positively or negatively affect retained earnings. For example, if your business merges with a profitable business, retained earnings might increase, while a divestiture could reduce the balance.

Legal or regulatory requirements

In some industries or regions, rules govern how much profit a business can retain. For example, some countries require banks and other regulated entities to allocate a portion of earnings for specific reserves instead of keeping all of it in a retained earnings account.

The broader economy

The strength of the economy also plays a role. In a strong market, businesses might hold onto more earnings for expansion. In leaner times, they might dip into retained earnings to cover losses or maintain dividend payouts.

Why is retained income important for growth?

Retained income is a key driver of growth. Unlike external funding (e.g. loans, issuing new equity), retained income is self-generated. It provides flexibility and sustainability for expansion without adding debt or diluting ownership. Beyond directly providing the funds for opening new locations, expanding production capacity, or investing in new technology or infrastructure, here are the ways retained income can make it easier for a business to grow:

• Fund research and development: Retained income provides funding for research and development (R&D). It lets businesses build and test new products, improve their offerings, and stay ahead of competitors without external approval or financing.

• Build a safety net: A healthy retained income account is a financial cushion. Businesses with strong retained earnings are better equipped to handle economic downturns and unexpected costs such as repairs or legal issues and make key moves as the market changes.

• Attract investors: Retaining earnings instead of distributing them can make a business more attractive to investors in the long term. Showing that the business is reinvesting in itself can signal higher profitability (and shareholder value) over time. Investors also often view reinvestment as a sign of forward-thinking leadership.

• Lower dependence on external funding: Outside funding comes with strings attached. Retained income lets businesses grow organically while retaining control over decision-making.

• Compound over time: When retained earnings are reinvested wisely, they generate returns that can also be reinvested in the business for a compounding effect. For example, if profits are retained to expand production and increased production leads to higher sales and more profits, then those profits can be reinvested as well.

• Support flexibility: Retained income gives businesses the freedom to move fast on attractive opportunities, such as acquiring a competitor, entering a new market, or launching a new product. Having retained earnings cash means your business won’t be waiting on financing.

How do businesses calculate retained income?

To calculate retained income, take the business’s retained income balance at the start of the period, add the net income (or subtract the net loss), and subtract any dividends (cash or shares). For this calculation, only declared dividends count – proposed dividend disbursements don’t affect retained income until they’re officially approved. This is the formula:

Retained Income = Beginning Retained Income Balance + Net Income or Loss − Dividends Paid

If there are restatements or corrections from previous periods (such as fixing a revenue error), adjust the starting balance accordingly.

Sample calculation

Imagine your retained income at the end of last year was£200,000. You earned £50,000 in net income and paid £20,000 in dividends. You add the net income to the starting retained income, then subtract the dividends.

Ending Retained Income = £200,000 + £50,000 − £20,000 = £230,000

At the end of the year, the retained income account balance is £230,000.

What are common mistakes in managing retained income accounts?

Retained income accounts are valuable for charting a business’s future, but these common pitfalls can put businesses at risk:

• Misclassifying dividends: Forgetting to deduct dividends from retained income or misplacing them in other accounts can make it seem as though the business has more profit to reinvest than it actually does and lead to poor decisions or compliance issues. Cash and share dividends reduce retained income, and if they’re not recorded properly, the balance will be overstated.

• Ignoring adjustments: Mistakes or changes in your accounting practices mean you need to adjust retained income from previous years. Skipping these adjustments can throw off your financials, create inconsistencies, and make it difficult for stakeholders to trust the numbers.

• Overpaying dividends: Paying out more in dividends than you have in retained income can run the account into a deficit. This will probably also restrict your ability to fund growth and might get your business into legal trouble.

• Overlooking restrictions: Loan agreements or regulations might restrict the amount you can distribute or reinvest. Ignoring these rules can result in penalties or lawsuits, or it can permanently damage your lenders’ trust.

• Not using retained income: Hoarding retained income without a plan for how you’ll use it is another trap. This is a missed opportunity to make retained income work in the business’s best interest.

• Confusing retained income with cash: Retained income is an accounting figure and does not mean the business has that amount of liquidity. Misunderstanding this can lead to cash flow issues.

• Not communicating with stakeholders: Decisions about retained income should be communicated clearly to shareholders and other stakeholders. If the reasoning behind reduced dividends or reinvestment isn’t explained well, it can create tension or misunderstandings.

• Overlooking tax implications: Retained income affects how profits and distributions are taxed, and mismanagement can lead to unexpected liabilities or penalties. It’s important to understand how reinvestment or payouts affect the business’s overall tax strategy.

• Over-relying on retained income: Relying on retained income as the only funding source for growth can be limiting. In some cases, accepting outside financing is a better option to accelerate growth, and being too conservative with retained income can lead to missed opportunities.

• Not reviewing an account regularly: Retained income accounts require active management. Routinely revisit your balance to make sure it’s working toward your goals and financial realities. As a business’s strategy evolves, retained income should reflect those changing priorities.