Dividend payout ratio shows what portion of available profits is distributed away as dividend. Hence, it also indicates what portion is being reinvested in the business.
The dividend payout ratio tells us what percentage of the firm’s earnings are being paid to Equity Shareholders in the form of dividends.
Dividend payout ratio is the ratio of total dividends to net profit after tax. The formula is given below:
or if express in percentage:
The net profit after tax of a trading company is $240,000. During the year the company declared and paid a dividend of $75,000. What is dividend payout ratio of the company?
Dividend payout ratio = ($75,000/$240,000) × 100
The company paid 31.25% percent of its profit to the shareholders as dividend and retained 68.75% profit in the business for growth.
A company that is in initial stages of development might find it necessary to retain a larger part of the profit in business to help it grow. On the other hand, a company that has adequate liquid resources may distribute a larger portion of its profits among shareholders. Local rules and regulations – in particular those imposed on listed companies by stock exchanges – also require companies to distribute adequate dividends to keep the interest of the shareholders alive.