The retained earnings total assets ratio is used to calculate the percentage of total assets funded by the retained earnings of a business. The ratio is an indicator of the extent to which the business is retaining it’s profits and using them to finance assets instead of paying out dividends, and using debt and new capital to fund it’s operations.
Retained Earnings Total Assets Ratio Formula
As can be seen below the retained earnings total assets ratio formula calculates the ratio by dividing the retained earnings by the total assets of the business.
Retained earnings total assets ratio = Retained earnings / Assets
How to Calculate Retained Earnings
When a business makes a profit it can either pay those profits out as dividends to equity investors, or it can keep (retain) them within the business. It is important to realize that if profits are kept within the business they count as part of it’s equity and can be used to fund the ongoing operations of the business.
The retained earnings shown on the balance sheet represents the accumulated profits and losses retained by the business since it commenced trading.
Both retained earnings and total assets are on the balance sheet of the business.
How To Calculate the Retained Earnings Total Assets Ratio
The balance sheet below is an example to show how we calculate the retained earnings total assets ratio.
|Long term assets||375,000|
|Total liabilities and equity||631,000|
As an illustration we have highlighted the numbers in the calculation of the retained earnings total assets ratio (RE/TA) in the balance sheet shown above. As can be seen In the example the retained earnings are 156,000 and the total assets are 631,000.
Accordingly using the formula, the retained earnings to assets ratio calculation is as follows.
Retained earnings total assets ratio = Retained earnings / Assets Retained earnings total assets ratio = 156,000 / 631,000 = 24.7%
In this case the ratio shows that 24.7% of the assets used within the business are funded by retained earnings. The balance of the assets (75.3%) must therefore be funded by liabilities and capital injected by investors.
Real Life RE/TA Ratio Examples
There is no correct value for the RE/TA ratio, generally a high ratio is a good thing. Its level will vary from industry to industry, and therefore it is important when making comparisons, to determine an industry ratio benchmark based on financial statements of businesses similar to your own.
To illustrate the difference in the RE/TA ratio from industry to industry, the following table sets out the calculation of the ratio based on the Apple Inc. and Amazon balance sheets.
Apple: Retained earnings total assets ratio = Retained earnings / Assets Retained earnings total assets ratio = 104,256 / 207,000 = 50.4% Amazon: Retained earnings total assets ratio = Retained earnings / Assets Retained earnings total assets ratio = 2,190 / 40,159 = 5.5%
The ratio of Apple (50.4%) is significantly higher than Amazon (5.5%), indicating that Apple has significantly more retained earnings that Amazon, and is able to fund it’s operations from internal resources rather than rely on external debt and capital injections.
The table below summarizes the results.
RE/TA = Retained earnings to total assets.
Understanding the RE/TA Ratio Formula
Using the formula the following we can make the following observations.
- If the retained earnings are equal to zero, then the ratio is equal to 0. None of the assets are funded by retained earnings and must therefore all be funded by either liabilities including debt or capital injected by equity holders.
- When the retained earnings are equal to the total assets the ratio is equal to 1 and the assets are funded entirely by retained earnings.
- When the ratio is 0.5 or 50%, the assets are 50% funded by retained earnings and 50% funded by liabilities and capital injected by equity holders.
The ratio forms part of the Altman Z Score ratio where it is used as an indicator of the age of a business (older businesses tend to have higher accumulated retained earnings and therefore a higher ratio), and as a measure of leverage, where a high ratio indicates that assets are funded from internal resources rather than from external injected equity capital or debt.
RE/TA Ratio and the Financial Projections Template
The RE/TA ratio is not directly shown on the financial projections template, but both the retained earnings and total assets are readily available on the balance sheet of the template, so it is a simply and worthwhile task to calculate the ratio using the formula above.
It must be remembered that most startup businesses have very little retained earnings and may even have accumulated losses in their early years. This situation means that the RE/TA ratio may be low or even negative in the first few years but should show signs of a gradual increase as the business becomes profitable and retained earnings increase (assuming dividends are not paid out).
In contrast a falling ratio might indicate that the business is unable to generate sufficient profit from its operations or that it is paying too much of those profits out by way of dividends to equity holders.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.