What are retained earnings?

What retained earnings means

Each year a company's profit after tax is added to its retained earnings, and any dividends paid are taken off. Losses reduce the balance. The running total appears in the equity section of the balance sheet, often labelled "profit and loss reserve" in UK accounts.

Closing retained earnings = opening retained earnings + profit after tax − dividends

Example

A consultancy company starts the year with £18,000 of retained earnings. It makes £60,000 profit before tax and pays £12,150 of Corporation Tax (£15,000 at 25% less £2,850 of marginal relief), leaving £47,850 after tax. The director takes £40,000 in dividends.

The £25,850 is available for future dividends, but it is not the same as cash in the bank. Some of it may be tied up in equipment or money owed by clients.

Why it matters for your business

In a UK company, dividends can only be paid out of distributable reserves, which for most small companies means positive retained earnings. A dividend paid when there are not enough reserves is unlawful. The director may have to repay it, and HMRC may treat it as a loan or as salary, with extra tax.

Before declaring a dividend, check up-to-date management accounts, including this year's profit to date and an estimate of the Corporation Tax due. Our salary vs dividend calculator helps plan the split.

Retained earnings vs cash

Retained earnings is an accounting figure, not a bank balance. A company can have £100,000 of retained earnings and an empty bank account if the profit has gone into stock, equipment or unpaid invoices. Equally, it can have cash but negative reserves after past losses. Both checks matter before you take money out.

Using retained earnings well

Profit kept in a company has only borne Corporation Tax, at 19% to 25%, rather than personal tax as well. That makes retaining profit an efficient way to fund growth, build a cash reserve or make employer pension contributions later. Many directors take enough dividends to stay within the basic rate band each year and leave the rest in the company, smoothing their personal tax over several years.