What Are Retained Earnings?

Retained earnings are the accumulated profits a company has kept rather than distributed — every year's result since incorporation, less every dividend ever paid. They sit inside equity on the balance sheet, and they are the single line that connects one financial year to the next.

They are also the most misunderstood line in the accounts, for one reason: retained earnings are not money. A company can hold 14,800 € of retained earnings and 6,200 € in the bank without any contradiction whatsoever.

The roll-forward

Retained earnings move by one formula, applied once a year:

Opening retained earnings
  + net profit for the year (or − net loss)
  − dividends declared
  ± transfers to and from reserves
= Closing retained earnings

For the company used throughout these articles, whose income statement showed a 9,400 € net profit:

	Amount
Retained earnings at 1 January	8,400
Net profit for the year	+9,400
Dividends declared	−3,000
Retained earnings at 31 December	14,800

That 14,800 € is exactly the figure on the balance sheet. Any movement in retained earnings that is not profit, loss, dividends or a reserve transfer is an error worth chasing — this is a line that should never move for a reason nobody can name.

How the profit gets there: closing entries

During the year, income and expenses accumulate in their own accounts (classes 5 and 6 in the Lithuanian chart of accounts). They are period accounts — they measure a year, not a state, so they cannot simply carry on.

At year end, closing entries zero them out and move the net difference into equity. In the Lithuanian chart the result lands first in account 3420 (ataskaitinių metų pelnas (nuostoliai) — current-year result), and after the shareholders' profit-appropriation decision it is transferred to 3410 (ankstesnių metų nepaskirstytasis pelnas — prior-year retained earnings), with any dividend and mandatory reserve split out at the same time.

Simplified, closing a 9,400 € profit:

Account	Debit	Credit
5001 Service revenue	180,000
6000 Cost of sales		104,000
6100 Selling expenses		21,000
6209 Administrative expenses		43,800
(other income and expense accounts, netted)	2,600	4,400
3420 Current-year result		9,400

Afterwards every class 5 and 6 account is at zero and the new year starts clean, while the balance-sheet accounts carry forward untouched. This is the mechanical reason the income statement never has an "opening balance" and the balance sheet always does.

Why retained earnings are not cash

This is worth stating bluntly because it costs companies real money every year.

Retained earnings are on the right-hand side of the accounting equation — they are a claim, not a resource. The profits they represent were earned, but the corresponding assets may now be anything at all: equipment, inventory, an unpaid customer invoice, or cash. Our example company's 14,800 € of retained earnings is invested in machinery and stock; only 6,200 € of the whole balance sheet is actually money.

The practical consequences:

• A company can have large retained earnings and be unable to pay a dividend, because the cash isn't there. Distributable profit is a legal test; liquidity is a separate one, and both must pass.
• A company can have negative retained earnings and plenty of cash — a loss-making startup living on invested capital.
• "We made a profit, where did it go?" is answered by the cash flow statement, never by the equity section.

Reserves and the legal limits

Retained earnings are not freely distributable in the EU. National company law constrains them, and the constraints bite:

• Mandatory reserve. Lithuanian companies must transfer at least 5% of the distributable profit each year to a legal reserve (account 3310) until it reaches 10% of share capital. That transfer moves value out of retained earnings without reducing equity — it just makes it undistributable.
• Losses first. Accumulated losses must be covered before any distribution.
• Negative equity triggers. Under Lithuanian law, if equity falls below half the share capital, shareholders must restore it or reduce the capital — a solvency rule watched at every year end. The Second Company Law Directive imposes comparable capital-maintenance rules across the EU.
• Interim dividends have their own conditions, typically requiring interim accounts showing sufficient distributable profit.

The short version: retained earnings are the ceiling on distributions, not the amount available. What can actually be paid is retained earnings minus undistributable reserves, and only if the cash exists.

Where the figure comes from

Retained earnings are derived, never typed. In Nordlet, POST /v1/reports/financial-statements returns the equity section broken into capital, reserves, retained earnings and the current-period result — retained earnings are the balance of chart group 34, and the period result is computed from the income and expense movement for the period rather than stored.

Two consequences worth knowing. Because the result is computed, the balance sheet is correct mid-year without any closing entries having been posted: the P&L accounts still hold the year's movement, and the statement reports it as the period result inside equity. And because the ledger is append-only with period locks, the closing entries that formalize the transfer are ordinary journal entries with a full audit trail — a prior year's appropriation cannot be quietly rewritten.

FAQ

Are retained earnings an asset?

No. They are part of equity — a claim on the assets, on the opposite side of the balance sheet. The assets the retained profits are invested in may be equipment, inventory or receivables; treating retained earnings as available money is the classic error.

What is the difference between retained earnings and net profit?

Net profit is one period's result; retained earnings are the accumulated total of every period's result since the company started, less all distributions. This year's profit becomes part of next year's opening retained earnings.

Can retained earnings be negative?

Yes — accumulated losses exceed accumulated profits, often shown as an accumulated deficit. It is normal for young companies funded by share capital, and a legal trigger when it drives total equity below the thresholds in national company law.

Do dividends reduce retained earnings or profit?

Retained earnings. Dividends are a distribution of profit already earned, not an expense of earning it, so they never appear in the income statement and cannot reduce taxable profit.

Why do accounts show both "current-year result" and "retained earnings"?

Because the two have different legal status until the shareholders decide. The year's result sits in its own account (3420 in the Lithuanian chart) until the profit-appropriation resolution allocates it to reserves, dividends and prior-year retained earnings (3410).