Question

retention ratio

Answer 1

Introduction:

To understand retention ratio fist, let us know the meaning of retained earnings. Retained earnings is part of profit which is re-invested in company as. It is very strong part of internal source of fund for any business, this is part of profit not distributed among shareholders but kept as reserve for future need. When need arises it will be invested back to business.

Meaning:

Now, retention ratio is measurement in percentage from company’s profit from the amount of net income which is retained or kept as reserve in any way to invest back in company and this is the amount which is not distributed among shareholders as dividend. This is the ratio at which company is re investing its profit to development of the business through different operations of business.

Formula:

Retention ratio = retained earnings/ Net income

Where, Retained earnings = net income- dividend distributed to shareholders

Here, the investors who want to earn more in current time will prefer low retention ratio. And investors who are growth oriented will prefer high retention ratio.

If retention ratio is high than company is reinvesting more profit back in business for growth of firm rather than distributing it as dividend, and if dividend payout ratio is high then company is distributing more amount as dividend from net income to shareholders rather than keeping it as reserves or re-investing it in business.

Retention ratio is exact opposite to dividend payout ratio. If dividend payout ratio is high retention ratio will be less as from net income more money is distributed among shareholders as dividend and wise versa.