Retained earnings

Retained earnings sits inside equity on the balance sheet and accumulates over the entire life of the company. Each period it increases by net income and decreases by any dividends paid.

It is the hinge between two statements. The income statement produces a profit for the period; that profit lands in retained earnings; the balance sheet balances again. Any three statement model works because of this link, and a model that fails to balance almost always has a broken connection here.

It is not cash, and the distinction matters. A company can have large retained earnings and no money, because the profits were reinvested in inventory, equipment or acquisitions years ago. Retained earnings records that profits were earned and kept, not that they are sitting in a bank account.

Negative retained earnings, often labelled an accumulated deficit, means the company has lost more over its life than it has earned. That is normal for a young growth business and a warning sign for a mature one.