Determine how much net income the company retains for future investments.
With the way today's market is moving up and down, companies worldwide are taking serious steps to ensure that their clients and investors are happy.
They do this by developing their operations, expanding their customer service options, and growing their businesses in general.
However, one crucial element companies and investors need to keep an eye on is the retention ratio. Is it too low? Is it sufficient enough for that future growth?
You can easily find all the answers as well as learn how to use our Calcopolis Retention Ratio Calculator if you read on.
What Is the Retention Ratio?
A company's retention ratio is a common financial metric that shows the amount of net revenue a company retains after paying out dividends to its shareholders. It's also often referred to as the plow back ratio.
It's an essential metric for investors and business owners alike as it shows how much of their profit is being invested—which can help their company grow and increase its value over time.
How to Calculate the Retention Ratio?
In order to figure out the retention ratio through our Calcopolis calculator, you'll need three main things:
- The net income of the company after taxes
- The total amount of paid dividends
- Their retained earnings
You can find any company's net income in the "Income Statement" section of its annual report, just after the part on income taxes.
On the other hand, finding its retained earnings takes a bit more effort. That's because you need to know how much the company paid in dividends first and then calculate what's left.
Fortunately for you, our Calicopolis Dividend Ratio Payout Calculator can help with that! It'll show you the precise payout ratio of a company so that you can use this formula:
Total Amount of Dividends Paid = Dividend Payout Ratio x Net Income
So, for instance, if you've got a company—let's call it Moorings—that has a net income of $750,000 and a 14.5% dividend payout ratio.
By applying the formula above, you'll get the following answer:
$750,000 x 14,5% = $108,750
Once you have the total amount of paid dividends, the retained earnings are just one subtraction away! It goes as such:
Retained Earnings = Net Income - Total Paid Dividends
So, Moorings' retained earnings are:
$750,000 - $108,750 = $641,250
With the retained earnings number, you can finally calculate the ratio by following these steps:
Retention Ratio = Retained Earnings ÷ Net income
That means Moorings has a retention ratio of:
$641,250 ÷ $750,000 = 0.855
For an accurate percentage, you can multiply the answer by a hundred. Hence, Moorings' retention rate is:
$641,250 ÷ $750,000 x 100 = 85.5%
What Is a Good Retention Ratio?
A good retention ratio varies widely from one company to the next. So, it's important to look at your specific needs when evaluating companies.
For instance, if you're looking to grow your portfolio's value, the retention rate of the companies you're investing in needs to be high. We're not saying it needs to be 90% or over, but it has to be enough for the company to grow and develop.
That's because your portfolio's value is assessed by the amount of monetary value within its assets. So, investing in a company that rolls our high dividend payout while its future growth is stunted can put you in a challenging position.
Even if you were only interested in the regular stream of income from the dividends, you'd still need to pay attention to the company's retention rate.
Again, the reason for that goes back to the importance of the company's future development and growth.
If the company can't sustain itself in the current market, it'll fail as it changes. As a result, you'll no longer be able to rely on the dividends as a steady source of income.
Is a High Retention Ratio a Good Sign?
A high retention rate could mean many things. For starters, take a look at the company you're investing in.
Is it still in its growth phase? Most companies still developing will likely keep more than 90% of their total income as retention money.
This is quite important because they're not a blue chip company and still need to build their brand and name. So, the high retention rate could just be a sign of a young business.
On the other hand, if the company is already established, isn't trying to grow anymore, and has a high or semi-high retention rate, that's a good sign.
It means that the company is reinvesting in itself and trying to maintain its stature in the market. In contrast, a low retention rate means that the company isn't doing much when it comes to development, which can harm future revenue and dividend payouts.
Created by Lucas Krysiak on 2023-02-16 16:34:09 | Last review by Mike Kozminsky on 2023-02-16 16:44:47