How to Prepare a Statement of Retained Earnings

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Most businesses come as a result of one good idea (for a product or service), offered to others or a price. But unless that product or service brings in enough money for you to make a good living, it won’t survive.

So, how do you know if you are making enough profit to make your business worthwhile? You “run the numbers” every so often to figure out what is called “retained earnings.” And when you put those numbers down on paper, it’s called a “statement of retained earnings.”

What is a Statement of Retained Earnings?

At its most basic level, this statement is the result of calculating all of the money you take in from sales, subtracting all of the costs of producing your product or service (also known as cost of goods sold – COGS), and the result will be your “retained earnings.”

And you do this on a regular schedule of your own choosing – monthly, quarterly, semi-annually, or annually. Here’s a simple example a retained earnings formula:

  1. A pool company took in $200,000 last year
  2. That company’s cost of doing business (salaries, equipment/supplies, marketing, taxes, etc) added up to $110,000.
  3. Simple math tells you that the company kept $90,000 of the $200,000 it took in.
  4. The owner can decide what to do with that $90,000 – maybe pay himself $80,000 and put $10,000 back into the business by buying some new equipment.

Why Do You Need a Statement of Retained Earnings?

The obvious purpose for putting retained earnings into the form of a statement is that you can see, on paper, what it is costing you to do business and whether you are earning enough to make it worthwhile to stay in business.

But there are a couple of other reasons for creating that statement:

  • You can compare the retained earnings over time, with each statement, to see if your business is growing at the rate you want.
  • File a series of retained earnings statements to show growth, if you want to go after a loan to expand.
  • You can use those statements as the basis to complete the Schedule C (profit and loss statement) of your 1040 Business Tax Return. Of course, you must have far more detail than just a total of your expenses, but this gives you a start point for preparing for tax season.
  • If you ever grow to the point that you are looking for investors, you have your statements of retained earnings over time to show that you are growing and financially healthy.
  • You can make better decisions about your future. Suppose, for example, that you have enough retained earnings in a period to pay yourself, to buy the new equipment you wanted, and still have some left over. You can carry that over for the future (cumulative retained earnings) for things you may want to do.
  • If you are not getting the retained earnings you want, these statements will show you that, and you can make decisions about such things as raising your prices or moving in a new direction.

The point is this: you need to know how much you are taking in, how much it is costing you to operate your business, and how much you actually have left over at the end of your chosen period of time. These are the essential premises of cash flow management for small business owners. You cannot make good business choices and decisions unless you know this. And having it in writing just makes it easier to see and compare.

How to Calculate Retained Earnings

To calculate retained earnings requires a simple formula. It is as follows:

Beginning Retained Earnings + Net Income for this Period

= Ending Retained Earnings.

Let’s first define each term.

  • Beginning Retained Earnings = Any carryover earnings from the previous reporting period that have not been spent or re-invested.
  • Net Income = the retained earnings accumulated during this reporting period. Remember, this figure is determined only after all costs of doing business have been calculated and subtracted from your total earnings.
  • Ending Retained Earnings = the figure you get from adding the two items.

How to Prepare a Statement of Retained Earnings: Step-by-Step

A statement of retained earnings can be prepared as a separate standalone document for your own personal use. Most small business owners prepare it for this purpose. But if you have an accountant who does your taxes, then asking that person for a separate statement of retained earnings is just a smart thing to do. You want to be able to refer to these on a regular basis, and they are much simpler than pouring through tax documents to get the figures you need.

If you are preparing your own statement of retained earnings, the following example will show you the hassle-free way to do it.

And if you need it to be more formal to show to others (going for a bank loan or looking for investors), this will work too. Statements of retained earnings can be used as summaries for the more detailed figures that these people will require. And they will show that you know what the most important information is – how much you are really making.

Use this template, and you will be fine.

The Heading

This usually consist of three lines: Name of Company on the first line, title of the document (Statement of Retained Earnings) on the second line. The third line must indicate the date of preparation and for what accounting period the report has been prepared. It would look like this:

ABC Pool Company

Statement of Retained Earnings

Quarterly Statement, December 31, 2018

Retained Earnings from Prior Reporting Period

This will be the first line item on your statement. It shows what retained earnings you have on account from previous earnings statements.

So, the first line on the actual statement will include a description and dollar figure. If you have taken a salary from the retained earnings, it cannot be included here. This is what you actually have on account that has not been spent on anything.

Retained Earnings Dec. 31, 2018 $25,000.00

Add Net Income from Your Income Statement

Let’s say you already prepared your income statement and calculated your net income. Remember, this figure is the result of adding all of your revenue and subtracting all of your expenditures, including your own distribution (the $ you have taken for your own salary).

This figure goes on the second line. So, your statement now looks like this:

Retained Earnings Dec. 31, 2018 $25,000.00

Quarterly Net Income Dec. 31, 2018 $46,000.00

Note: If your net income statement is negative, reflecting a loss, the loss figure is either placed in parentheses or with a “-“ sign, because it will have to be subtracted from the retained earnings on the first line.

Reconcile the First Two Lines

If both lines are positive, then you simply add them together and place in the third line:

Retained Earnings Dec. 31, 2018 $25,000.00

Quarterly Net Income Dec., 2018 $46,000.00

Total Dec. 31, 2018 $71,000.00

Subtract any expenses that are a part of this quarter but haven’t been paid out yet.

You may have invoices coming in that were a part of this quarter’s expenses, but you haven’t paid them yet. Your pool company may have ordered supplies in November, but the invoice hasn’t been sent to you yet.

These are your “Accounts Payable” and they should be included to the calculation.

Retained Earnings Dec. 31, 2018 $25,000.00

Quarterly Net Income Dec., 2018 $46,000.00

Total Dec. 31, 2018 $71,000.00

Accounts Payable Dec. 31, 2018 $ (8,000.00)

Insert the Final Total

Subtract the “Accounts Payable” figure from the total. The result is $63,000.00.

Retained Earnings Dec. 31, 2018 $25,000.00

Quarterly Net Income Dec., 2018 $46,000.00

Total Dec. 31, 2018 $71,000.00

Accounts Payable Dec. 31, 2018 $ (8,000.00)

Retained Earnings Dec. 31, 2018 $63,000.00

You now have your statement of retained income complete. It’s clear, precise, and easy for anyone to understand.

Additional Details

Some businesses want to add more detail to their retained income statements, such as the sources of the net income during the reporting period. Still other companies may include details of net income based on sales. This figure, of course, is calculated by the total income from sales minus the cost of goods sold (COGS).

It’s up to you how much detail you want to put in your Statement of Retained Income. If you have an accountant who is preparing detailed quarterly profit and loss statements, then you really don’t need to include more detail in your retained earnings statement. Remember, it’s really just supposed to be a summary.

Stay Compliant

When completing any financial statements, you should always check in with your accountant. There may be updated formats and principles of accounting that should be adhered to, not to mention new compliance requirements from Uncle Sam!

But if you are using your retained income statement for your own purposes and not for submission to any authority, you really do not have to worry about format. The important things is for you to have your own record, so that you can make smart business decisions!

Photo by Michal Jarmoluk. 

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