How to Calculate Plowback Ratio?

You might have heard of the plowback ratio before, but you might not know what it means. It’s a financial ratio that measures the amount of earnings that are reinvested back into a business. However, some people find it hard to calculate plowback ratio. 

You can calculate this by taking the retained earnings, which are earned profits not distributed to shareholders, and dividing them by the net income, which is the total amount of money remaining. This will be more fully explained somewhere in this article. 

We’ll discuss what a plowback ratio is and outline the formular for plowback ratio. We will also look at some plowback ratio examples and what this could mean for businesses. 

What is the plowback ratio?

The plowback ratio is a financial ratio that measures how much of a company’s net income is being reinvested into the business instead of paid out to shareholders. The plowback ratio can be calculated by dividing the amount of retained earnings (retained earnings) by net earnings. The plowback ratio is also referred to as the retention ratio. The opposite of this is the dividend payout ratio. 

A higher retention ratio simply signifies that a company’s growth potential is high and they are bound to succeed. On the other hand, a high dividend payout ratio, which is the amount of earnings given to shareholders, signifies that the company might not be growing as expected. It’s difficult for a company that produces a low retention ratio to report growth potential. The more earnings a company retains and reinvests, the more growth the company will experience. 

How to Calculate Plowback Ratio

You don’t need a plowback ratio calculator to get the correct value. Here’s the formular for plowback ratio:

Plowback Ratio = Retained Earnings (I.e. net income – dividends) / Net Income

We can as well say that: 

Payout ratio= Dividends / Net Income

Therefore, formular for plowback ratio can also be: 

Plowback ratio= 1- Payout ratio

Let’s take a look at some plowback ratio examples: 

Example #1

Frank & Co. is a company that sells assorted wines in bulk to wholesalers. In a year, the company makes about 20 million U.S. dollars in net earnings. The company gives out about 5 million dollars to its shareholders. Using a plowback ratio calculator, find the plowback ratio for Frank & Co. and confirm if there’s growth potential or not. 

Solution

We have net earnings=$20,000,000, Dividends=$5,000,000, plowback ratio=?

Plowback ratio= (net income – dividends)/ net income

Plowback ratio= (20,000,000 – 5,000,000)/20,000,000

Plowback ratio= 15,000,000/20,000,000

Therefore, the plowback ratio= (0.75 x 100)= 75%.

Hence, the plowback ratio is higher than the payout ratio (25%). Frank & Co. has growth potential. 

Example #2

Jonathan is asked to calculate the plowback ratio of his organization’s earnings, assuming that the net earning for the year is $500,000 and dividends have been shared, resulting in a 25% payout ratio. Help Jonathan calculate the plowback ratio. 

Solution

We have net earnings= $500,000; payout ratio= 25%, plowback ratio=?

Plowback ratio= 1 – payout ratio

Plowback ratio= 1 – 25%

Therefore, the plowback ratio calculator equals 0.75 x 100= 75%.

What does the plowback ratio mean for businesses?

As we already discussed, the plowback ratio is a financial ratio that measures the amount of cash retained by the company after paying dividends and making investments. It is the percentage of earnings retained by the company, which is calculated by dividing the retained costs by the total capital employed. But what exactly do businesses need to understand after they calculate their plowback ratio? From the plowback ratio examples above, it could mean two things. Firstly, your shares and income are either being kept for future reinvestments or they are being given out to stakeholders, which could in turn affect your growth potential. Shareholders could be interested in a growth potential company or an income potential one. 

Conclusion

Before you calculate plowback ratio, you should determine what each value means and how the results can be used. 

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