Finance Infopedia Logo
Menu
  • Start Here
  • Personal Finance
  • Equity
  • Invest in USA
  • Fundamental Analysis
  • Mutual Fund
    • Debt Fund
  • Macro Economics
  • Products
    • Equity Investment Library
    • My portfolio
    • How to do a “Quick Test” to study business performance
    • Financial Ratios Analysis Tutorial with DCF method of Valuation
  • Passive Income
    • Blogging
  • Cryptocurrency
  • Quotes
  • Aggregated Content
  • About
    • Contact Us
    • Do Business Together
    • Vision and Mission
    • Jobs
    • Privacy Policy
    • Terms Of Use
  • Forum
  • My Portfolio
Menu

How To Calculate Reinvestment Rate of a Business?

Posted on February 15, 2022February 19, 2022 by Finance Infopedia

What is meant by reinvestment rate?

Reinvestment rate means the rate at which management of a company reinvests the net profit achieved in a year back into the same business. The term “rate” means the percentage of net profit reinvested back to the business.

How to calculate the reinvestment rate?

If you want to find this ratio only for one year, you can find it simply by taking the amount of change in capital employed at the beginning of this year and dividing it by the net profit reported at the end of last year.

ie

(Capital employed in this year – Capital employed in the previous year)/ Net profit of the previous year

The amount of change in capital employed can be identified from the balance sheet and net profit can be identified from the profit and loss statement from a company’s annual report.

Finding the reinvestment rate of a company for the last 10 years or so is a bit difficult to calculate but still very much possible if you are ready to learn and understand. So, here it goes

The formula to calculate the reinvestment rate for “X” years is

Change in capital employed in last “X” years / Cumulative earning in last “X” years

“X” is the number of years that you are considering in the calculation

For example, assume that “X” years is 9 years, and the period to calculate the reinvestment rate is from 2013 to 2021

Here, we are trying to find out how much of the total sum or cumulative profit of the company earned during the period from 2012 to 2020 (9 years) are reinvested back to the business in the period 2013 to 2021(9 years).

If you refer to the below-given table. Capital employed in the business at the beginning of the financial year 2012 was Rs. 500 Cr. and the company reported a net profit of Rs. 100 Cr. at the end of the financial year 2012. Out of 100 net profit, the company took Rs. 90 Cr. and reinvested back to the business and hence the capital employed in the year 2013 changed to Rs. 590 Cr. (Rs. 500 Cr. + Rs. 90 Cr.). The same process continued again. In 2013 out of Rs. 122 Cr. profits reported Rs. 111 Cr. is reinvested back to the business and that changed the capital employed in the year 2014 to Rs. 701 Cr. (Rs. 590 Cr. + Rs. 111 Cr.)

YearCapital employed in the business at the beginning of the financial yearNet profit at the end of the financial yearNet profit from the end of each FY reinvested back to the business
201250010090
2013590122111
2014701145134
2015835155143
2016978164154
20171132176167
20181299189168
20191467198179
20201646202192
20211838

Based on the above table, the total change in working capital in 9 years from 2012 to 2021 is Rs. 1338 and the sum of net profit created in 9 years from 2012 to 2020 is 1451. If you take the reinvestment rate by dividing Rs. 1451 with Rs. 1338, you will get the reinvestment rate is 92%. Meaning, for every 100 bucks created as net profit, Rs. 92 is reinvested back to the business. Look at the table given below.

Change in working capital between in 9 years from 2012 to 20211338
Sum of net profit created in 9 years from 2012 to 20201451
Sum of net profit at the end of each FY reinvested back to the business1338
Reinvestment rate92%

Assuming that you understood how the reinvestment rate is calculated, let us try to understand what way you should look at a company having a high investment rate.

Advantage of high reinvestment rate

What can a company do using net profit? They can

  • reinvest the amount back into the business,
  • issue dividends,
  • pay off debt or
  • use the amount to buy back shares

Every option has its need and benefits which I am not going to explain in this post. But when the company is reinvesting a major chunk of its profit back into its business, that shows the growth potential of the company and that shows the potential future earnings growth.

When a company reinvest its profit at a high rate and on that reinvested capital if the company is able to maintain a healthy ROCE, that is what an investor must look for.

For a company to grow, they need to invest more in capital expenditure (CAPEX) and operations expenditure (OPEX). By reinvesting the profit back to the business, the company can meet the expenses for growth of the business without taking debt or without issuing more shares to the public (which will cause equity dilution).

Hence, considering all other ratios as equal, if I have options to invest in a company, I go for the one with the highest reinvestment rate.

Share this:

  • WhatsApp
  • Facebook
  • Twitter
  • Print
  • LinkedIn
  • Reddit
  • Tumblr

Related

Our Products

Subscribe To Our Newsletter

* indicates required
Author
Finance Infopedia

Hai,

My name is Ashlin Joby Thekkan. Living in Kerala in India (also known as God’s own country). Over the last 10 years, I have read and researched a lot on topics like personal finance management, equity investing etc. Now I can proudly say that all my efforts have helped me to gain knowledge and expertise in the field of equity investment and personal finance management.

I realized that the level of financial literacy among people, even among those who are well educated is very low. The moment I realized my passion for teaching personal finance management and investing, I started looking for platforms through which I can reach out to the public and teach them on related topics. I found that blogging is the right platform for me to reach out to a large audience and that helped me to become the founder of Finance Infopedia.

Categories

Recent Posts

  • Type Of Promoters You Can Find In The Market
  • Why do I like equity investment? 17 Reasons Explained.
  • What Is Meant By Stock Market Index?
  • Protected: Quick Analysis Of A Business
  • Fundamental Analysis of Asian Paints Ltd.
©2023 Finance Infopedia | Design: Newspaperly WordPress Theme