What it means
Retained earnings is the running total of every profit and loss the company has made since it started, less any dividends paid. It sits in the equity section of the balance sheet. When the total is negative, as it is for most startups, it's called an accumulated deficit.
If the P&L is one season's scorecard, retained earnings is the career total.
Revenue and expense accounts only measure one year. At year end they're closed: their balances go to zero and the year's net result moves into retained earnings. The new year's P&L starts from nothing, and retained earnings carries the history.
Money investors put in is kept separately, in stock and additional paid-in capital. That's why a startup can have plenty of equity from its raises and a large accumulated deficit at the same time.
Acme ends the year with $600,000 of revenue and $1,500,000 of expenses, a $900,000 net loss. The closing entry zeroes revenue and expenses and debits retained earnings $900,000. If Acme began the year with a $400,000 accumulated deficit, it opens the new year at $1,300,000. That opening figure should match the signed statements for the year just closed.
This is the line that ties the P&L to the balance sheet. Corrections to a closed year are a conversation with your CPA, and materiality decides whether one becomes a restatement.
Why it matters. It links the P&L to the balance sheet. If last year's closing balance doesn't equal this year's opening balance, someone changed a closed year.
Try it with your numbers
Change any number. The working below updates as you type.
Closing = Opening + Adjustments + Net income − DividendsCommon and preferred stock plus additional paid-in capital.
Accumulated deficit at year end
($5,000,000.00)
How it’s worked out
- 1OpeningLast year's closing balance($3,200,000.00)
- 2Prior-period adjustmentsCorrections of errors in earlier years$0.00
- 3Net income (loss)From this year's P&L($1,800,000.00)
- 4DividendsDeclared in the year$0.00
- 5Closing($3,200,000.00) + $0.00 + ($1,800,000.00) − $0.00($5,000,000.00)
- 6Total stockholders' equity$12,000,000.00 + ($5,000,000.00)$7,000,000.00
The opening balance must equal last year's signed closing balance. A prior-period adjustment is booked here, not through this year's P&L, and is disclosed. Stock comp and new shares move paid-in capital, not retained earnings.
The entry, worked
Acme's year ends with $600,000 of revenue and $1,500,000 of expenses, a $900,000 net loss. The year-end close zeroes the income statement accounts, shown here in summary.
| Account | Debit | Credit |
|---|---|---|
| Revenue | $600,000.00 | |
| Retained earnings | $900,000.00 | |
| Expenses | $1,500,000.00 | |
| Total | $1,500,000.00 | $1,500,000.00 |
Revenue and expenses start the new year at zero, and the year's $900,000 loss is carried in equity.
Common questions
Is an accumulated deficit a bad sign?
Not for a venture-backed startup. It means the company has spent more than it earned so far, which is the plan. Investors look at it alongside cash and runway.
Do I need to make the closing entry myself?
Most accounting software closes the year automatically when it rolls over. The check is that the opening balance matches last year's final statements.
Where does a correction to a closed year go?
A material error in a prior year is fixed by restating that year, and the cumulative effect on earlier years goes to opening retained earnings of the earliest year shown, under ASC 250. It never runs through this year's P&L as if it were new.
Where it comes up
The glossary entries, founder guides and lessons on this site that use the term and link here.
- Retained earningsAccumulated net income not distributed to owners — where the P&L lands on the balance sheetGlossary
- How to read an income statement (P&L)Revenue, cost of revenue, gross margin, operating expenses and net income, read line by line, on accrual basis, with the mistakes founders make most.Guide · 7 min
- Balance sheet explained for startupsAssets equal liabilities plus equity. What each startup line means, from deferred revenue to the SAFE and the accumulated deficit, and why it must balance.Guide · 7 min
- General ledger and double-entry bookkeeping, explainedHow double entry works: journal entries, debits and credits, normal balances, running balances, the trial balance, and why posted entries are reversed.Guide · 6 min
- Chart of accounts for startups: a starting templateA starting chart of accounts for a US startup: number ranges, the expense accounts you need, and when to add an account versus a class or tracking tag.Guide · 6 min
- The balance sheetThe other three account types, at one instant — and the single line where the month's profit lands, which is what ties the two statements together.Lesson 11
- The accounting equationAssets = liabilities + equity is not a formula you apply at period end. It is true after every single entry, and that is what makes the books provable.Lesson 2
- The income statementTwo of the five account types, arranged so each subtotal answers a different question about how the month went.Lesson 10
Read further
General information for US companies, not tax, legal or accounting advice. Check the specifics with a CPA before you act on them.