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How to Prepare a Retained Earnings Statement in 5 Steps
January 13, 2021
How to Prepare a Retained Earnings Statement in Steps

How to Prepare a Retained Earnings Statement in 5 Steps

As a business owner, you should always be aware of your company’s earnings. One way to manage this is to create a retained earnings statement, also known as a Statement of Owner’s Equity.

In this post, we’ll explain what a retained earnings statement is, how you can create one, and how you can use this financial statement to your business’s advantage.

What is a Retained Earnings Statement? 

A Retained Earnings Statement is essential if you’re a small business owner. It highlights retained earnings, which is the amount of net income or profit you receive after you pay dividends to stockholders.

There are numerous factors that may affect this figure including changes in net revenue, cost of goods sold, administrative costs, taxes, and business strategy. Fortunately, you can prepare a Statement of Retained Earnings in five simple steps that we’ll go over below.

1. Create a Header

First and foremost, create a header at the top of the statement and add three lines. The first line can list your business name while the second line says “Statement of Retained Earnings.” The third line should state the financial year you plan to calculate retained earnings for such as “Fiscal Year Ended 2021.”

2. State the Retained Earnings Balance From the Previous Year

Once you write a header, add the balance of retained earnings that you’re carrying over from the previous year. Let’s say your balance of retained earnings from 2020 was $25,000. Here’s what the first line of your Retained Earning Statement would look like:

Retained Earnings, December 31, 2020: $25,000

3. Add Net Income or Loss

Next, take a look at your income statement so you can list your Net Income or Less. If your business had a net income of $15,000, for example, your Retained Earnings Statement would now look like this.

Retained Earnings, December 31, 2020: $25,000

Plus: Net Income 2021: +$15,000

Total: $40,000

Of course, if your business experienced a net loss, you’d subtract that figure from your retained earnings.

4. Subtract Investor Dividends 

If your business provides dividend payments to shareholders, subtract this number from your net income. In the event it does not, subtract $0. If you pay out half of your net income to your investors, for instance, you’d pay out $7,500 and subtract this amount from your total. Using this formula, your Retained Earning Statement would look like this:

Retained Earnings, December 31, 2020: $25,000

Plus: Net Income 2021: +$15,000

Total: $40,000

Minus: Dividends ($7,500)

Keep in mind that your dividends are considered a debt so they’ll reduce your retained earnings, regardless of if you’ve paid them out.

5. State the Final Total for Retained Earnings

Last but not least, calculate the final total for your Retained Earnings Statement. You can apply this amount to the retained earnings line on your balance sheet. Here’s what you can expect your final statement to look like with our example:

Retained Earnings, December 31, 2020: $25,000

Plus: Net Income 2021: +$15,000

Total: $40,000

Minus: Dividends ($7,500)

Retained Earnings: December 31, 2021: $32,500

You should also consider creating an optional section that includes special notes related to your retained earnings. These notes may describe stock purchases, new issuance of stocks, or other important information.

Retained-Earnings-Statement

What is the Purpose of a Statement of Retained Earnings?

With a Statement of Retained Earnings, you’ll know how your retained earnings have changed over time. This can help you gauge how your business is doing financially and offers a complete picture of your profitability.

As a business owner, it can tell you whether you’re ready to launch a new product or service, fund an expansion, or move forward with a merger or acquisition. You may want to do one of these things if your retained earnings account is positive. In the event it’s negative, however, you have a deficit and should wait until it turns positive.

For current and potential investors, a Retained Earnings Statement can show how your company uses its profit. If you reinvest a portion of your profits into business growth opportunities, for example, you’ll appear attractive in their eyes.

A Statement of Retained Earnings may also be useful to lenders. If it indicates you’re retaining your profits, they’ll have more confidence in your ability to repay a potential loan. This can lead to a loan approval as well as a  lower interest rate and more favorable terms.

Retained Earnings vs. Revenue 

Even though retained earnings and revenue get used interchangeably, there are differences between the two terms. Revenue is the income you earn from the sale of goods or services and is seen on the top of an income statement.

Retained earnings, however, is the profit of the income statement and found in the shareholder’s equity section of the balance sheet. While revenue shows the market demand for your offerings, retained earnings is ideal for shareholders as it determines their equity and calculates the book value of your business.

Conclusion: Retained Earnings is a Crucial Financial Metric 

Retained earnings explains how your business has handled its profit. By preparing a Statement of Retained Earnings, you can assess the financial growth of your business over a given period of time. You may also make smart financial decisions that allow you to meet (or even exceed) your unique goals.

Fora Financial

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

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