Most often, retention ratio refers to the percentage of a company’s earnings that are not paid out as dividends to stockholders and are held back by the company. The earnings that are reinvested in the business are called retained earnings or retained capital. To calculate the ratio, a person can deduct the dividends from the company’s net income, and divide that total by the net income.
Investors are interested in learning a company’s retention ratio because a higher ratio means that more money is put back into the company. This can mean the company is poised for growth. Retained earnings can also be held back to pay for planned expenses, such as purchasing a building or new equipment. Since money is plowed back into the business, this percentage is sometimes called the plowback ratio.
Investors can use the retention ratio to calculate the maximum sustainable growth rate of a company. This growth rate is determined by multiplying the company’s return on equity by the ratio. The return on equity can usually be found in the company’s annual report. The maximum sustainable growth rate can be a factor when an investor decides whether or not to invest in a particular company.
A low retention ratio means that more money is paid out to stockholders. Investors looking for stocks to provide income generally look for companies with lower ratios. Companies with a history of such low numbers usually try to maintain these ratios, since investors come to expect dividends each year.
The term can also refer to a customer retention or insurance retention. When applied to customers, this number is the percentage of those that keep purchasing products and services from a particular company. A high figure can indicate quality goods or service. In other words, a high customer ratio equals satisfied customers.
Insurance retention ratio is the amount of business an insurance company retains. This is calculated based on premiums, or the amount each person pays for insurance coverage. Paid premiums represent sales. In insurance, this ratio is the percentage of invoiced, or written, premiums compared to the number of premiums that are actually paid, called gross premiums.
While number can refer to different numbers in various industries, it maintains a common theme. Retention refers to something a company keeps. Retention can refer to sales, customers, or earnings, depending on the context in which ratio is used.