What is a Retention Rate?

In terms of finance, a retention rate refers to the rate or amount of earnings that are kept by a business after it has settled any dividend payments to investors. Sometimes known as a retention ratio or a plowback ratio, this percentage reflects the net income of the company that remains in the possession of the business once dividends are disbursed. The rate is typically presented as a percentage.

The process for determining the retention rate is very simple, since the figure has to do with net income rather than gross income. This means that taxes have already been deducted from the amount of revenue used to determine the plowback ratio. From there, it is simply a matter of deducting the total amount of dividends that are paid out to investors for the period under consideration, and dividing that figure by the net income.

For example, if a business generates $10 million US dollars (USD) in net income and pays out dividends of $1 million USD, this would leave an amount of $9 million USD as net income after dividends. By dividing the amount left after dividends by the net income, it is possible to determine that the company experienced a retention rate of 90%, a figure than many companies would find highly desirable.

The goal of most companies is to realize the highest retention rate possible while still providing investors with dividends that are considered attractive and equitable by those investors. When a business is able to achieve this balance, there is more money to pump back into enhancing the existing operation, or expanding the business by establishing a presence in a new market, funding research and development processes. By making sure there is an appreciable amount of net income retained for these purposes, it is possible to set courses of action that will ultimately benefit both the owners and the investors of the firm.

When a company experiences a relatively low retention rate, steps are usually taken to identify the reasons behind the lackluster percentage. This may lead to making changes in the production process employed by the company, evaluating the costs of raw materials used in that production, or reorganizing the corporate structure to eliminate positions that are considered obsolete or nonproductive. Here, the idea is to trim costs without adversely affecting the quality of the products offered to consumers and thus increase the amount of net income that is generated in general.