Net Income vs. Retained Earnings: Understanding Their Importance for Business Growth

December 2025

Eva Koziel
Accounting & Advisory Services (CAAS) Manager

Cray Kaiser
 

Understanding the difference between net income and retained earnings is essential for any business owner who wants to build long-term profitability. While these two accounting terms are closely related, they serve different purposes and offer valuable insights into your company’s financial health.

What Are Retained Earnings? 

Retained earnings represent the leftover net income after dividends have been paid to owners or shareholders. Instead of being distributed these profits are reinvested, back into the business forming a fundamental part of equity. These funds can be leveraged for various productive uses, including financing new projects, investing in research and development, or upgrading infrastructure.

In other words, retained earnings reflect how much profit your business has chosen to retain for future growth rather than pay out. This healthy practice forms an important part of the shareholders’ equity section on your balance sheet and also strengthens a company’s financial position over time.

How To Calculate Retained Earnings 
The formula for retained earnings is a simple formula:
Retained Earnings (RE) = Beginning RE + Net Income – Dividends.

For example:

If a business. begins the year with $300,000 in retained earnings, earns $100,000 in net income and pays out $20,000 in dividends, the ending retained earnings  would be $380,000.

What Is Net Income? 
Net income measures how much money your company earns after all taxes, operating costs and expenses have been deducted. It’s a key indicator of the company’s profitability for a specific period. It’s important to note that while net income contributes directly to retained earnings, the two serve different purposes:.

Net income shows short-term profitability.
Retained earnings show how much of those profits are reinvested over time.
It’s also important to note that net income is taxable, while retained earnings are not, since taxes have already been paid on those profits.

How Dividends Affect Retained Earnings 
Dividends represent the portion of profits distributed to shareholders, typically paid in cash or as stock dividends. To maintain healthy dividends, a company must ensure they have sufficient retained earnings to support these payouts while also funding growth.

Where to Find Retained Earnings on Financial Statements
You can find retained earnings in the equity section of your balance sheet, typically on the right side, along with liabilities and shareholder equity. Some companies also prepare a separate statement to track retained earnings, showcasing the inflow and outflow of these critical funds.

Common Mistakes in Calculating Retained Earnings
Even simple calculations can go wrong if not handled carefully. When tracking retained earnings:

Adjust for prior period errors or restatements.
Reflect changes in accounting policies accurately.
Consider tax implications linked to dividend payments.
 

Accurate calculations ensure your financial statements reflect the true state of your company’s growth and performance.

Why Understanding Net Income and Retained Earnings Matter
Both net income and retained earnings are more than just numbers, they’re essential indicators of financial health and business growth strategy. By understanding these concepts:

You can make more informed decisions about allocating profits.
 You’ll identify opportunities for reinvestment or debt reduction.
You’ll strengthen long-term financial stability.
 

Take the Next Step Toward Smarter Financial Management
A clear understanding of net income versus retained earnings helps business owners build smarter growth strategies and maintain financial resilience.

Ready to delve deeper? Our Client Accounting and Advisory Services can review your Retained Earnings and help you plan for sustainable business growth. Contact us today to schedule a consultation.