Quick answer: What are retained earnings?
Retained earnings are all the profit a business has made over its lifetime, less everything paid out to its owners in draws, distributions, or dividends. You calculate them as opening retained earnings plus net income minus payouts. The figure lives in the equity section of the balance sheet and records where equity came from — it is not cash. Kantivo keeps it clean for you: this year's profit shows on its own balance sheet line until Year-End Close moves it into Retained Earnings as a single dated journal entry you can open and check.
A dog groomer's balance sheet says $22,000 of retained earnings. Her business account says $6,000. She assumes something is broken. Nothing is — she's just reading a history figure as if it were a bank balance, which is the most common way owners misread this line.
This guide answers the question properly: what are retained earnings, how does the number get built, where does the money behind it actually go, and what should you conclude when it turns negative? We'll follow one small business across three years, then cover the handful of bookkeeping habits that quietly corrupt the figure.
Retained Earnings, Defined
Everything the owners of a business can claim — its equity — arrives by one of two routes. Either someone invested it (owner contributions, capital, share purchases), or the business generated it and held onto it. That second route has a name: retained earnings.
Each year's result feeds it. Profit adds to it; losses subtract. Whatever the owners take out subtracts as well. The balance never resets, so the figure on your balance sheet today is the net sum of every profitable year, every lean year, and every withdrawal since the doors opened.
That permanence is why you'll find it on the balance sheet rather than the profit and loss report, which starts from zero every year. What links the two is the year-end closing entry: the transaction that lifts a year's profit off the income statement and deposits it into retained earnings.
Why don't my retained earnings match my bank balance?
Because the figure answers "where did this equity come from?" and not "where is it now?" Profit that stayed in the business rarely stays as cash. It becomes a new piece of equipment, a lower loan balance, extra stock on the shelves, or an invoice a customer hasn't paid yet. The retained earnings line still remembers that the profit was earned and kept — it just can't tell you what it turned into. The asset side of the balance sheet does that.
How to Calculate Retained Earnings
There's only one formula, and every input is already in your books:
Closing Retained Earnings = Opening Retained Earnings + Net Income (− Net Loss) − Owner Draws, Distributions, or Dividends
Opening retained earnings is last year's closing figure. Net income is the bottom line of the income statement. Payouts come from your draw or distribution accounts — not payroll, which is an expense. If the difference between those two is fuzzy, owner's draw vs salary sorts it out.
What does retained earnings look like over several years?
Tidewater Dog Grooming opened in 2023. Here's its retained earnings, year by year:
| 2023 | 2024 | 2025 | |
|---|---|---|---|
| Opening retained earnings | $0 | $16,000 | $22,000 |
| + Net income (loss) | $36,000 | $51,000 | ($4,000) |
| − Owner draws | ($20,000) | ($45,000) | ($26,000) |
| Closing retained earnings | $16,000 | $22,000 | ($8,000) |
In 2025 a burst pipe closed the salon for five weeks, the year ended $4,000 in the red, and the owner still drew $26,000 to cover her household. Retained earnings dropped below zero — despite $87,000 of profit in the first two years. The arithmetic is honest: across three years Tidewater earned $83,000 and paid out $91,000, leaving kept earnings $8,000 short.
And the opening puzzle? At the end of 2024, Tidewater's $22,000 of retained earnings sat beside $6,000 of cash because the owner had spent $11,000 on a second grooming station and paid $5,000 off her equipment loan. Sixteen thousand dollars of kept profit had simply changed shape. The cash flow statement is the report built to trace exactly that.
How the Label Changes With Your Business Type
Different legal structures dress the same idea in different words:
| Business type | Payouts are called | Where it typically shows |
|---|---|---|
| Sole proprietor / single-member LLC | Draws | Frequently folded into an Owner's Equity or Capital account, though plenty of small-business ledgers keep a separate Retained Earnings account |
| Partnership / multi-member LLC | Partner draws | Split across each partner's capital account under the operating agreement |
| S corporation | Distributions | Retained Earnings in the books — this can differ from the tax return's own accumulated adjustments figure, so check with your CPA |
| C corporation | Dividends | Retained Earnings, shown apart from stock and paid-in capital |
The principle behind GAAP-compliant double-entry bookkeeping holds in every case: money the owners put in stays separate from profit the business kept. Blend them and nobody — you, your accountant, your bank — can tell whether the company is self-funding. GAAP for small business covers why that line matters so much to lenders.
Is Negative Retained Earnings Bad?
A figure below zero is an accumulated deficit: over its life the business has lost or paid out more than it has earned. Context decides whether to worry:
- A new business still building. Expected. Early deficits are routine while owner investment carries the startup costs.
- A single rough year after solid ones. Generally manageable, provided withdrawals come down to match.
- Steady profits, but bigger withdrawals. The real red flag. Owners are pulling out more than the business produces, and the gap is being plugged with debt or by drawing down the original investment. It's one of the first patterns a loan officer checks for.
Four Habits That Distort Retained Earnings
Accountants taking on a new client often start with the equity section, because that's where years of small errors collect. These four cause most of the damage:
- Skipping the year-end close. With no closing entry, earlier years' profit is still stranded in revenue and expense accounts, and retained earnings reflects nothing but its opening figure.
- Booking straight to Retained Earnings. Fixes, write-offs, and "make it balance" plugs dropped directly into equity never pass through the income statement. They vanish from every year's profit and the balance stops tying out.
- Putting last year's corrections into this year. When the CPA's adjustments arrive in spring, entering them in the current year patches the balance sheet but misstates two years of profit. Reopen the old year, post them there, and close it again.
- Letting draws pile up forever. Draw accounts that are never closed into equity leave retained earnings inflated by every dollar the owner has ever withdrawn.
Is it okay to record entries straight into retained earnings?
Very rarely. The year-end close is the only routine entry that should touch it; the one exception is a documented correction of an earlier period that your accountant has approved. Everything else belongs in a revenue, expense, asset, or liability account, where the reports designed to explain it can see it. A pre-close trial balance is the fastest way to spot anything sitting in the wrong place.
In Kantivo: your balance sheet lists the Retained Earnings account and, separately, a Net Income (Current Period) line for the year in progress, so accumulated profit and this year's profit never get muddled. Go to ⚙️ Company Settings → 📅 Year-End Close and Kantivo surfaces any fiscal years that were never closed — as far back as 10 years — shows each year's net income for your approval, and posts one dated closing entry per year. After that, a transaction dated inside a closed year pauses and asks before it can alter numbers your tax return relied on.
An Equity Section You Can Trust
Kantivo is GAAP-compliant double-entry accounting that lives on your own machine. It keeps the current year's profit on its own line, closes each year into Retained Earnings with an entry you can open and read, and protects closed years from backdated edits. One flat annual price, no monthly fees.
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Retained earnings is the lifetime tally of profit your business has generated and held onto: add each year's result, subtract what the owners drew, carry it forward indefinitely. It isn't cash, it isn't this year's performance, and a minus sign is information to act on rather than an error to bury.
Because it never resets, it's also the figure where old bookkeeping mistakes live longest — an unclosed year or a plug entry from years ago still skews it now. Close every year, keep contributions and draws in their own accounts, and leave Retained Earnings to the closing entry, and it'll be one of the most reliable numbers you own.
Want to see how it all connects? Our free interactive double-entry accounting course lets you record entries and follow them into the financial statements, in a sandbox, at whatever pace suits you.
Frequently Asked Questions
What are retained earnings, in plain language?
Retained earnings is everything a business has earned in profit over its whole life, less everything it has handed to its owners through draws, distributions, or dividends. It lives in the equity section of the balance sheet and rises in any year where profit outpaces payouts. Think of it as a historical tally of profit that stayed in the business, not as a balance you can withdraw.
What is the formula for retained earnings?
Take the retained earnings figure you started the period with, add the period's net income (or subtract a net loss), then subtract whatever the owners withdrew as draws, distributions, or dividends. A business opening the year at $16,000 that earns $51,000 and pays its owner $45,000 closes the year at $22,000.
Why don't my retained earnings match my bank balance?
Because retained earnings describes the source of your equity, not its current location. Profit the business held onto has usually been turned into something else — equipment, stock, a smaller loan, or invoices customers haven't paid yet. So a large retained earnings figure can sit alongside a thin bank account, and the asset side of the balance sheet shows where the kept profit ended up.
Is negative retained earnings bad?
Not automatically. A negative figure, known as an accumulated deficit, just means lifetime losses and owner payouts together exceed lifetime profit. New businesses spending ahead of revenue often show one. It becomes a warning sign in a mature business when owners consistently withdraw more than the business earns, because the shortfall is then being covered by borrowing or by the owners' original investment, and lenders look for that.
Where will I find retained earnings on my reports?
On the balance sheet, in the equity section, next to owner capital or common stock. Until the year is closed, accounting software typically lists the current year's profit as its own equity line, since it has not been transferred into retained earnings yet. Corporations may also produce a statement of retained earnings that walks from the opening balance through net income and distributions to the closing balance.
Is it okay to record entries straight into retained earnings?
Very rarely. The only routine entry that should touch retained earnings is the year-end close, with the occasional exception of a documented prior-period correction your accountant approves. Booking ordinary transactions or clean-up adjustments directly to retained earnings skips the income statement, so they never appear in any year's profit and the equity balance stops tying out.
Related Articles
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