Your quick guide to retained earnings (and what to do with them)

If you’re running a business, you’ve probably heard the term retained earnings thrown around—but what does it actually mean, and why should you care?

In short, retained earnings are the part of your business’s profits that you’ve chosen to keep in the business, rather than paying out to shareholders or yourself as dividends. They're savings you’re putting aside to grow, protect, and future-proof your business.

Keen to learn more? Let's break it all down.

What are retained earnings?

Retained earnings are the part of your business's net income (read: your hard-earned profit) that you hang on to, rather than distribute to shareholders as dividends (read: profit payouts).

Retained earnings can be positive or negative. If they're positive, you have more money to reinvest in your business. If they're negative, you've spent more than you've earned—which might signal early-stage investment, growing pains, or a need to review your strategy.

How to calculate retained earnings

The retained earnings formula is: Retained earnings = Beginning retained earnings + Net income (or loss) - Dividends.

Let's go through it step by step:

1. Beginning retained earnings

Your beginning retained earnings are the total retained earnings your business had at the start of the period, usually the start of the financial year. You can usually find this number on the balance sheet from the previous period (under the equity section) or in your accounting software.

Think of it like a starting balance in a savings account, which shows how much you've saved up (read: kept in the business) before profits or losses for this year are factored in.

2. Net income/loss

Next, you need to find the profit (or loss) your business made over the current year after all expenses are accounted for. This is often referred to as your bottom line, and you can find it on your profit & loss statement.

In a nutshell, if your business earned more than it spent, you add the profit to your beginning retained earnings. If it spent more than it earned, the loss reduces retained earnings. Whatever figure you get is the value your business created (or lost) during the year.

3. Dividends paid

Your dividends paid is the total amount you've distributed to shareholders during that period. Since you can no longer reinvest this money into your business, it reduces your retained earnings.

These aren't an expense, so they don’t appear on the profit & loss statement. Instead, they're distributions of profit and will usually be in your equity records or general ledger.

4. Year-end retained earnings

This is your final result: what you’ve kept in the business after profits (or losses) and payouts.

Let's put this all into practice. Say at the end of last year, your beginning retained earnings for this year are also $100,000. Over the current year, you earned a net profit of $60,000 and paid $20,000 in dividends. Plug it all into the formula, and this is what you get:

$100,000 + $60,000 - $20,000 = $140,000

Your retained earnings at year-end are $140,000.

How retained earnings impact your SME

Your retained earnings can:

• Fuel your business growth, as you can use the profits you’ve already earned to buy new equipment, expand your team, launch new products, and more.
• Improve your financial stability by providing you with a cash flow buffer you can turn to in tough times—say if sales slow down or customers pay late.
• Help build trust with banks, lenders, and investors—who'll often look at your retained earnings when assessing your business health and creditworthiness. Growing retained earnings tells them your business isn't only making money but also managing it wisely.
• Tell you how your strategy’s going—and where there may be room to refine it. For example, you may find you're paying out too much too soon or holding back too much and under-investing.
• Support your loan application, not only by showing that your business has been profitable and responsible with cash, but also by proving you're reinvesting in the business (and not just paying yourself out). These green flags can reduce your perceived risk and lead to better borrowing terms and higher approval chances.

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We manage the paperwork, handle the application, and help get your funding sorted—so you can stay focused on growing your business. So, if your retained earnings tell a strong story, let's use that to your advantage. Reach out today to get started.

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Where do you report retained earnings?

As a type of equity, your retained earnings appear on your balance sheet, under the shareholders' equity section. As you close out each accounting period, they're updated to reflect what you’ve earned, kept, or paid out.

Retained earnings vs profit: What's the difference?

We've mentioned the word 'profit' a few times throughout this article, but if you're new to business finance, you may be wondering what exactly the difference between retained earnings and profit is. The two concepts are easy to mix up, so let's clear it up.

Profit is the amount of money your business earns during a specific period after subtracting all expenses, taxes, and costs from your revenue.

Retained earnings are the accumulated profits your business has kept and reinvested over time—after paying out any dividends to owners.

In other words, profit is the new money coming into your business, and retained earnings are the total savings you’ve built up over time.

Factors that impact your retained earnings balance

Your retained earnings don’t just magically grow. We already know your business net profit or loss and dividends will heavily influence this figure, but what else can move the needle?

• Your business structure (whether you're a company, sole trader, or partnership)
• Adjustments to past financial statements, like correcting errors or revaluing assets
• Unexpected events, like lawsuits, write-offs, or disasters

What to do with retained earnings

So you've ended the quarter or year with positive retained earnings. What now? There are a few smart ways you can put this extra cash flow to work:

• Reinvest in the business. Use the capital to upgrade gear, hire new staff, expand your product line, or improve marketing—whatever will help grow your business further.
• Pay off debt. Cut down what you owe to reduce interest costs, strengthen your financial position, and open up resources for new opportunities.
• Build a cash reserve. Set aside a 'rainy day fund' to keep you afloat during slow periods, help you cover unexpected expenses, or take advantage of new opportunities quickly.
• Distribute dividends. Share your success directly by rewarding your shareholders with dividends.
• Upgrade systems and processes. Invest in better technology or workflow improvements to increase efficiency, lower costs, and support scalable growth.

What if your retained earnings are negative?

If you've spent more than you've earned and your retained earnings balance is negative (what's sometimes called an accumulated deficit), there are a few things you can do to manage the situation:

• Work on increasing net income to turn the balance positive over time, for example by adjusting your prices or upselling to existing customers
• Avoid paying dividends until you build up positive retained earnings again
• Keep a close eye on expenses to help control costs and improve cash flow
• Talk to your accountant or financial advisor to plan a path back to positive retained earnings

Keep in mind that negative retained earnings aren't uncommon for startups that haven't turned a profit yet or businesses investing heavily in growth. But if your losses are ongoing or starting to affect cash flow and funding options, it may be time to adjust your strategy.

FAQs

Are retained earnings taxed in Australia?

No, retained earnings aren't directly taxed. Instead, your net profit is taxed and then the remaining amount can be retained in the business or paid out as dividends.

Do sole traders have retained earnings?

Technically, sole traders don’t have retained earnings like companies do. Instead, profits from the business are treated as personal income and taxed accordingly. Any leftover profit after expenses and tax is available for the owner to keep or reinvest.

Can I use retained earnings for personal expenses?

If you're a sole trader or in a partnership, yes, because there's no legal separation between you and your business [1].

If, on the other hand, you're a company, then you can’t use retained earnings for personal expenses directly, unless you pay yourself a dividend (if you're a shareholder) or a salary (if you're also a director/employee).