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Plowback Ratio In Finance

However, if a company expects a business downturn, then using this ratio to invest in stock could prove wrong. It is possible that the company in increasing the retention level to prepare for the downturn that it expects in the future. Moreover, a sharp drop in the retention how to calculate plowback ratio ratio could also be if the company doesn’t see any profitable investment opportunities in the near future. A high retention ratio could mean that the management feels there is a need for cash internally, and that it would generate a higher return than the cost of capital.

how to calculate plowback ratio

The retention ratio is often higher for expanding companies that rake in huge and rapid revenues and profits. A company that keeps a considerable part of its net income is likely to experience more growth or opportunities for expansion. A bookkeeping retention ratio is a ratio or measure of how much income is retained after dividends are paid out to investors. A retention ratio is defined as the total ratio of income retained by an investment after dividends are paid out to investors.

Alternative Formula

Other investors would sooner see a high ratio, showing the company is investing in growing its operations. If a company’s growth is sluggish, a high plowback ratio means they’re simply hanging on to the money but not using it. The retention ratio is the portion of earnings kept back in a firm to grow the business as opposed to being paid out as dividends to shareholders. As understood by shareholders who invest in the company, the higher the earnings retention ratio, the growth of the business or the how to calculate plowback ratio company also increases, there by raising the prices of the shares as well. Having this is a concern the shareholders might want to control their shares and finances they have invested in the company shares. As a share holder of the company shares, he might not think that there are any advantages of Earnings retention ratio. When a business is growing at a rapid rate, there should be a high plowback ratio, since all possible funds are needed to pay for more working capital and fixed asset investments.

However, if the company is holding back funds for unproductive purposes, then investors may end up with a negative return on the funds. Similarly, investors can easily understand how to calculate the plowback ratio of a company. There are different formulas to cash basis calculate the plowback ratio of a company. Companies can also use different formulas and understand how to find optimal plowback ratio. Likewise, a company that is looking to invest in any future projects is also more likely to retain earnings for future use.

Advantages And Disadvantages Of Plowback Ratio

Ted’s TV Company earned $100,000 of net income during the year and decided to distribute $20,000 of dividends to its shareholders. However, since 2012, the company is paying a dividend, and its retention ratio now is in the range of 70 %to 75%. High retention has helped Apple to register massive growth in the past years.

how to calculate plowback ratio