What is Retained Earnings?
Retained earnings explained in plain English. Learn what retained earnings means, how it appears on your balance sheet, and why it matters for freelancers and small business owners.
What Are Retained Earnings?
Retained earnings is the cumulative total of your business's net income (profits) over its entire lifetime, minus any dividends or owner draws paid out to shareholders or owners. It represents the portion of earnings that have been retained in the business rather than distributed — reinvested in operations, held as cash reserves, or used to pay down debt. Retained earnings is an equity account — it belongs to the owners or shareholders of the business. As a sole proprietor, your retained earnings are part of your owner's equity. As an LLC or corporation, retained earnings belongs to the company and is tracked separately from your personal draws. The concept is straightforward: if your business earned $100,000 in net profit over five years and you took $60,000 in owner draws, your retained earnings would be $40,000. That $40,000 represents the value the business has generated and kept.
How to Calculate Retained Earnings
Retained Earnings = Beginning Retained Earnings + Net Income − Owner Draws/Dividends For a new business with no prior earnings, beginning retained earnings starts at $0. Example for a Single-Member LLC | Item | Year 1 | Year 2 | Year 3 | |---|---|---|---| | Net Profit | $40,000 | $55,000 | $48,000 | | Owner Draw | $30,000 | $35,000 | $40,000 | | Retained Earnings (cumulative) | $10,000 | $30,000 | $38,000 | By Year 3, the LLC has retained $38,000 of cumulative profit in the business after the owner withdrew $105,000 total.
Retained Earnings vs. Revenue
This is a common confusion: - Revenue is income earned in a given period (e.g., $80,000 this year) - Retained earnings is cumulative net income minus distributions since the business started Revenue doesn't equal retained earnings because: 1. Expenses reduce profit 2. Owner draws reduce retained earnings 3. Losses reduce retained earnings A business can have $1M in revenue but negative retained earnings if expenses and draws exceed that.
Retained Earnings on the Balance Sheet
The balance sheet equation: Assets = Liabilities + Equity Equity is broken down into components: - Common Stock / Paid-in Capital (amount invested by owners) - Retained Earnings (cumulative profits retained in the business) - Owner's Draw (for sole proprietors — tracked separately from retained earnings) Here's a simplified balance sheet for a freelancer: | | Amount | |---|---| | Assets | | | Checking Account | $25,000 | | Accounts Receivable | $12,000 | | Equipment | $3,000 | | Total Assets | $40,000 | | Liabilities | | | Credit Card | $3,000 | | Total Liabilities | $3,000 | | Equity | | | Owner's Capital | $5,000 | | Retained Earnings | $32,000 | | Total Equity | $37,000 | | Total Liabilities + Equity | $40,000 |
Can Retained Earnings Be Negative?
Yes. If a business consistently loses money or owners draw more than the business earns, retained earnings becomes negative — also called "accumulated deficit." This is a red flag for lenders and investors, showing the business has historically spent more than it has earned.
How It Relates to Invoicing and Business
Your retained earnings is essentially your business's "savings account" — the value it's accumulated. If you operate as a sole proprietorship and regularly withdraw everything you earn, your retained earnings will be minimal. If you reinvest in your business (equipment, hiring subcontractors, marketing), your retained earnings grows. Understanding retained earnings also helps when applying for business loans. Lenders look at it as a measure of your business's financial history — positive retained earnings demonstrates sustained profitability. Related reading: - Balance Sheet Explained → - Net Profit: The Bottom Line → - Equity in Business → Key Takeaways: 1. Retained earnings = cumulative net income − owner draws/dividends 2. It appears in the equity section of your balance sheet 3. Positive retained earnings means the business has kept profits over time 4. Retained earnings can be negative if draws or losses exceed profits 5. Reinvesting in your business increases retained earnings Track your business equity and profitability — Try Eonebill Free