Categories

# How to Calculate the Retention Ratio

A retention ratio is the percentage of earnings that are not paid out as dividends. Instead, these earnings are credited to the company’s retained earnings. This is the opposite of the dividend payout ratio. The retention ratio is also referred to as the retention rate. This ratio is a crucial one for investors to know. Here are some ways to calculate this ratio. Using the ratio to calculate the size of your company’s retained earnings is a great way to gauge its profitability.

## Retained earnings

The retention rate refers to the proportion of earnings a company retains rather than paying out as dividends. This is the opposite of the dividend payout ratio. In other words, retained earnings are credited to the company’s books rather than being distributed as dividends. This ratio is an important financial metric because it is the basis for determining a company’s future profitability. Here are some important facts about retained earnings:

Unlike plowback percentage, retention rate is higher for companies that are new or young. Established companies tend to have lower retention rates because they’ve already established themselves, so they have a higher need to pay dividends. A recent case in point is Apple, a high-tech manufacturer that started giving out dividends in 2010.

## Net income

When it comes to profitability, a company should retain as much of its net income as possible, and should not take money from retained earnings, which are earnings left over after paying all expenses, taxes, and dividends. There are two ways to calculate retention ratios: a per-share basis and a total basis. Net income is the amount a company makes and distributes to shareholders. Retained earnings are the amount a company retains as a percent of its total revenue.

A company’s retention rate indicates how much of its profits are reinvested into its operations. Retained earnings are similar to a savings account: the money left at the end of a fiscal year can be reinvested into the business or distributed as dividends to shareholders. A high retention rate is a good sign for a growing company, but it is a poor sign for a company that has been in business for a long time. If it doesn’t reinvest its profits, the company will likely suffer from a lack of earnings growth and may have to issue more debt or issue equity shares to fund growth.

## Dividends distributed

Retention ratio is a measure of profits reinvested in a firm and is often referred to as the “plowback” ratio. It measures the amount of profits that are retained by a company rather than distributed as dividends to its shareholders. A higher retention ratio is a sign that a company isn’t paying out as many dividends as it could, and the stock price may be increasing because of the company’s future growth prospects.

For example, say a company is a well-established, highly profitable business, with a high retention rate. The dividend it pays is relatively low compared to its net profit, making it appealing to income investors. Dividends distributed to improve retention ratio may also be a factor of timing, with the board of directors authorizing the distribution but not paying out the dividend until later. Then, dividends distributed to improve retention ratio may be negatively affected by the timing of the distribution, making the retention ratio lower than it would otherwise be.