Dividend Payout Ratio Formula Step By Step Calculation Example

Dividend Payout Ratio Formula

A dividend is the portion of the profit that the company shares with its shareholders, and the formula to calculate dividend payout is the percentage ratio of this dividend paid to the shareholders to the net profit for the year.

Here’s this formula –

Dividend Payout Ratio = Dividends/Net Ratio

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Explanation

For a company, sharing the profit is an after-thought. First, they decide how much they will reinvestReinvestReinvestment is the process of investing the returns received from investment in dividends, interests, or cash rewards to purchase additional shares and reinvesting the gains. Investors do not opt for cash benefits as they are reinvesting their profits in their portfolio.read more into the company to grow bigger, and the business can multiply the shareholders’ money instead of just sharing it. That’s why this formula is important.

It tells us how much a company pays dividends to the shareholders. And also how much the company is reinvesting into itself, which we call “retained earnings.”

Sometimes, a company doesn’t pay anything to the shareholders because they feel the need to reinvest its profits so that the company can grow faster.

Since the net profits of the company are only used for two purposes, we can conclude that –

Net Income = Retained Earnings + Dividend Payments

If anyone of the above is nil (among retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more and dividend payments), the entire profit is distributed or invested in the other.

If an investor looks at the company’s income statement, she would be able to find the net income for the year. And in the balance sheet, retained earnings would be found. So if you need to know how the company has calculated the retained earnings and dividends, you can check the footnotes under the financial statements.

Example

Let’s look at a practical example of dividend ratio calculation.

As mentioned in the example, we will use two methods to calculate this ratio.

First, we will use the first ratio.

We know that the dividends paid in the last year were $140,000. And the net profit was $420,000.Using the first ratio of the dividend payout formula, we get –Dividend ratio = Dividends / Net Income = $140,000 / $420,000 = 1/3 = 33.33%.

Now, we will use the second ratio.

We know that 66.67% was kept as retained earnings.

That means the retention ratioRetention RatioRetention ratio indicates the percentage of a company’s earnings which is not paid out as dividends but credited back as retained earnings. This ratio highlights how much of the profit is being retained as profits towards the development of the firm.read more is 66.67%. Then, using the second method, we get –Dividend payout ratioDividend Payout RatioThe dividend payout ratio is the ratio between the total amount of dividends paid (preferred and normal dividend) to the company’s net income. Formula = Dividends/Net Incomeread more = 1 – Retention Ratio = 1 – 66.67% = 1 – 2/3 = 1/3 = 33.33%.

Apply Dividend Payout Ratio Calculation

Let’s look at a practical example to understand the dividend ratio better –

source: ycharts

Till 2011, Apple didn’t pay any dividends to its investors. Because they believed that if they reinvested the earnings, they would be able to generate better returns for the investors, which they eventually did.

Uses

Understanding the equation between retained earnings and dividend payments will help an investor comprehend a company’s short-term and long-term goals.

Since many companies also pay a 100% dividend, we can also use an alternative formula for calculating the dividend payout ratio.

Here’s the alternative formula –

The retention ratio is the percentage of profits the company keeps for reinvestment.

Looking at the last dividend payout ratio formulaPayout Ratio FormulaThe payout ratio formula calculates the amount announced as a dividend out of the total earnings (after-tax profits). There are two formulas to calculate the dividend payout ratio using the earning method and the outstanding method. Payout ratio (earning method)= Total dividend paid/Total earning.read more, the investors get ensured about how much they may receive in the near future.

Calculator

You can use the following Dividend Payout Ratio Calculator

Calculate Dividend Payout Ratio in Excel (with excel template)

Let us now do the same example above in Excel.

This is very simple. You need to provide the two inputs of Dividends and Net Income.

You can easily calculate the ratio in the template provided.

Dividend Payout Ratio Formula Step By Step Calculation Example