What is the Retention Ratio? Meaning and Usage
🔥 The retention ratio (also "Retention Rate") is a financial indicator that quantifies the proportion of earnings that are kept by a firm for internal use (to be reinvested or perhaps for tax benefits) rather than being distributed as dividends to shareholders.
Calculating Retention Ratio. Formula
The retention ratio is determined by dividing the company's Retained Earnings
by the overall earnings for the time period. The percentage that arises, shows how much of the profits are being put back into the company.
Since the company's earnings retained are added to the beginning balance of retained earnings to calculate the period's ending balance of retained earnings, the retention ratio and retained earnings are closely related.
Example of Retention Ratio
As an illustration, if a corporation earns $1 million in profits for the year and keeps $600,000 of those profits to reinvest in the company, the retention ratio is 60% ($600,000 / $1,000,000). The ending balance of retained earnings for the year would be calculated by adding the $600,000 to the beginning amount of retained earnings.
Usage of Retention Ratio
The retention ratio is a crucial measure for investors since it sheds light on a company's potential for growth and future profitability. An organization may be growing and becoming more profitable in the future if it has a high retention ratio, since that indicates that a sizable amount of its earnings are being reinvested in the company.
On the other hand, a low retention rate means that the business is paying out a lot of the money it has earned. Apparently it has low growth possibilities. Otherwise the management would probably have decided to reinvest it.
The retention ratio is the inverse of the Dividend Payout Ratio