By James Bell
Retention Ratio is the ratio of Net Income that comes back to the business after dividends are paid. This amount can be reinvested back into the business. Not all companies pay dividends and some of them you don’t want them to right now.
The idea when they do not pay dividends is that they can provide a better return to the stockholder by reinvesting the money back into the company. This is typical with growth companies. More mature companies that do not see as steep of growth and typically pay more dividends. This is where a lot of the value of the return can stem from.
Net Income, to me, is an accounting construct. The principles, laws, and rules of Accounting include a lot of grey area and this is why a lot of Finance formulas back out or add in items such as non-cash expenses, changes in net working capital, capital expenditures, etc. as a basis for formulae.
Rant aside, this is Revenue – Expenses and you can find it at the bottom of the Income Statement.
We are looking at the total paid out of all dividends for all of the stock in this equation. A board of directors may decide to pay out some of the companies profits to it’s shareholders rather than investing it back into the company. This usually happens quarterly but it can happen at any time really if the company chooses so. If your company is not set up as a corporation, then the “owner draws” can be considered the same as dividends. Keep this in mind when running calculations on companies not set up as corporations.
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