Retention Rate (Plowback Ratio, retained ratio) in the field of finance refers to a percentage of the income received or a fixed amount of money that the business leaves at its disposal after all dividend payments to investors have been made. Sometimes this term can be referred to as a retention ratio or a plowback ratio. However, most often, this coefficient is set as a percentage.
Retained ratio definition
Retained ratio definition is easy to remember. The profit retention rate is the rate of reinvestment of profit in fixed assets.
When a company maintains a relatively low retention rate (retained ratio), it is necessary to determine the reasons for this situation. This may lead to changes in the production process, an estimate of the cost of raw materials used, or a reorganization of the corporate structure to eliminate positions that are outdated or unproductive.
The idea of such actions is to cut costs without having a negative impact on the quality of the company’s products (services), and thus increase the amount of net income, which will increase the retention rate.
Retained ratio how to calculate with the formula
The process of determining the retention rate (retained ratio) is quite simple since it refers to net income, not gross income. This means that all taxes have already been deducted from the amount of income used to determine the coefficient. The retention rate is calculated as the ratio of the difference between the amount of net income and dividends paid to the amount of net income.
Retained ratio examples
For example, according to the retention ratio calculator, if a company made a net profit of $350,000 in the current period and paid a dividend of $75,000, then the retained earnings will be $275,000. In this case, the retention rate (earnings retention ratio) will be equal to (350,000-75,000)/350,000 = 78.57%.
The goal of most companies is to maintain the highest retention rate possible while still paying dividends that will be attractive to investors. When a company is able to achieve this balance, it has more money at its disposal that can be invested in improving existing activities, expanding the business, entering new markets, and financing research activities.
By leaving a substantial portion of net income at your disposal, you can do strategic planning that will ultimately benefit both the company’s owners and investors. Thus, the retained ratio formula and examples are important for the company’s success.
The retention rate shows how much of a company’s profit it holds and reinvests in its business. This ratio is, therefore, useful for investors who want to invest in a company based on growth potential. A company with a higher retention rate has a higher percentage of net profit available for its use. Due to the additional funds, it can use a company with a higher retention rate is more likely to experience higher growth rates in the future. The retention rate finance depends directly on the company’s dividend policy. It can be changed at the discretion of its management while increasing the return on capital, which is a more difficult task.