UK Accounting Glossary
Earnings Retention Ratio measures the percentage of earnings retained after dividends have been paid out to the shareholders. Other names for the Earnings Retention Ratio are Plowback Ratio, Retention Rate and Retention Ratio.
The philosophy behind the Earnings Retention Ratio is that the more earnings the company retains, the more capital it has available for growing the business. There is always a conflict when it comes to the Retention Ratio as company managers would like to see a high level of earnings retention, while shareholders would think otherwise.
The formula for Retention Rate first calculates the retained earnings by subtracting dividends paid from the net income. Then the Retention Rate is calculated by dividing the retained earnings by the net income.
Investors prefer to have a high retention ratio in a high growth business, and a low retention ratio in a slow growth (mature) business. Company growth is not only due to the retention of earnings but also other factors. Therefore it is not sufficient to simply look at the Earnings Retention Ratio without examining the entire business.
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This glossary post was last updated: 22nd March 2020.