In plain English
Each year's net income closes into retained earnings. Distributions or dividends reduce it.
Changing a closed year can alter it.
Why it matters
Retained earnings connect your profit reports to your balance sheet across years. If the number changes after a year was closed and filed, something in a prior year was edited, and the opening balances your accountant used no longer match. That is often the first sign of a problem in the books.
Lenders and buyers look at this figure to see whether the business has been building value or paying out more than it earns.
Worked example
Starting $15,000 + net income $23,000 - distributions $10,000 = $28,000.
How to handle it
- Note the retained earnings balance on the first day of each new year after the books are closed.
- Set a closing date or password in your software so prior years cannot be edited by accident.
- Compare the current year's opening retained earnings to the prior year's return or final balance sheet.
- If they differ, run a report of changes to prior-year transactions to find what was altered.
Common mistakes
- Posting entries directly to retained earnings to make the balance sheet balance, which hides the real error.
- Editing old transactions after the return is filed, which silently changes the opening balance.
- Recording a sole proprietor's draws against retained earnings in a way that does not match the entity type your accountant set up.
Not the same as: Net income
Net income is one period's profit. The area is the running total of all past profits kept in the business, after losses and distributions. See Net income.
Go deeper
- Closing Entries and Retained Earnings Explained: How the year-end close resets income and expense accounts to zero, rolls profit into the area, and what to watch if numbers look wrong.
Try it
Related terms
- Revenue: The money a business earns from selling goods or services before expenses.
- Sales tax payable: Sales tax collected from customers that you owe to the state.
- Retainage: A percentage of a construction or project payment held back until work is complete.
Common questions
What is retained earnings?
The profit a business has kept over time, after distributions, rather than paid out.
Can you give an example of retained earnings?
Starting $15,000 + net income $23,000 - distributions $10,000 = $28,000.
Why does my retained earnings change on January 1?
On the first day of the year, the software closes the prior year's net income into the area. That jump is normal and should equal last year's profit, adjusted for distributions if your setup records them there.
Can retained earnings be negative?
Yes. A negative balance, sometimes called an accumulated deficit, means past losses and distributions have exceeded past profits. It is common in young businesses but worth watching.
General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.