What is Retention Ratio
The retention ratio is a financial ratio that measures the percentage of a company's net income that is retained by the company rather than being paid out as dividends to shareholders. It is calculated by dividing net income by dividends and expressing the result as a percentage.
For example, if a company has net income of $100,000 and pays out dividends of $50,000, its retention ratio would be 50% (100,000 / 50,000 = 2, which can be expressed as a percentage by multiplying by 100). This means that the company is retaining 50% of its net income, while the other 50% is being paid out to shareholders.
The retention ratio is an important financial metric because it indicates how much of a company's profits are being reinvested in the business rather than being distributed to shareholders. A high retention ratio can indicate that a company is retaining a large portion of its profits in order to fund growth or pay off debt, while a low retention ratio may indicate that the company is not generating enough profits to fund its operations or that it is returning a larger portion of its profits to shareholders.