How to Calculate the Return on Retained Earnings
The return on retained earnings is a financial metric used to assess the profitability of a company’s reinvested earnings. It measures how effectively a company has utilized its retained earnings to generate additional profits.
Formula
The formula to calculate the return on retained earnings is:
Return on Retained Earnings = Net Income – Dividends / Retained Earnings
Where:
- Net Income is the total profits earned by the company.
- Dividends represent the amount of profits distributed to shareholders as dividends.
- Retained Earnings refer to the portion of net income that is reinvested in the business.
Example
Let’s consider the following example:
- Net Income: $500,000
- Dividends: $100,000
- Retained Earnings: $300,000
Using the formula above, we can calculate the return on retained earnings:
Return on Retained Earnings = ($500,000 – $100,000) / $300,000 = 1.33
The return on retained earnings in this example is 1.33.
A high return on retained earnings indicates that the company is effectively reinvesting its profits to generate additional income. On the other hand, a low or negative return may signal inefficiency or poor investment decisions.
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