Retained earnings

Retained earnings is the cumulative total of all net income a company has generated since inception, minus all dividends paid out to shareholders over that same period. It's the portion of historical earnings that has been reinvested in the business rather than returned to owners. Share repurchases return capital to shareholders too, but they reduce shareholders equity through a separate treasury stock line rather than through retained earnings directly.

It's the single line on the balance sheet that most directly connects the income statement to the balance sheet: every dollar of net income earned in a period increases retained earnings, every dividend paid reduces it, and the ending balance carries forward into the next period as the starting point.

The formula is:

A large and growing retained earnings balance generally signals a profitable business that has consistently earned more than it has distributed. An accumulated deficit, a negative retained earnings balance, means cumulative losses have exceeded cumulative profits since inception, common in early-stage, capital intensive, or restructured businesses that absorbed significant losses before reaching profitability.

Retained earnings is also the primary source of internally generated equity financing. A profitable company can fund its growth from the earnings it retains rather than issuing new shares or taking on debt, avoiding both dilution and interest costs. The payout ratio, dividends divided by net income, and its complement the retention ratio, measure how much of each period's earnings gets returned to shareholders versus retained, a decision that reflects management's view of its reinvestment opportunities relative to what shareholders could earn elsewhere.