Question

Our text defines “payout ratio” and “plowback ratio”. Why is this important? How would you use these two ratios in a specific example?

Answer 1

Payout ratio and plowback ratio both are important because both tells about the use of profits of the firm. In simple words we can say that payout ratio tells that how much profits has been distributed amongst the shareholders. Hence with the help of payout ratio, all stakeholders can get information about portion of profits distributed to the shareholders.

On the other hand plowback ratio tells about the portion of profits retained in the firm for internal use, hence with the help of plowback ratio all stakeholders will know about the retention of profits for inside purpose which could have distributed to the shareholders if not retained.

Thus it is clear that both playout ratio and plowback ratio are important for financial planning of the firm and for the external users as well.

Suppose payout ratio is given 60% then it is clear that plowback ratio will be (100 – 60) 40%. Hence on the basis of these two ratios a firm can make future & present policies regarding finance such as; capital structure, dividend policy, capitalization, impact of dividend policy on the value of share and value of firm etc. On the other hand external users can make various comparison with industries averages to know the true performances of the specific firm.

So finally we can say payout ratio and plowback ratio both are important.