Disposal of Profits
The main objectives of a firm are to maximise the shareholders’ wealth. Cash generated from the successful operation of business are generally distributed among the shareholders’ in the forms of dividend. But a company may also decide not to pay dividend to their shareholders if it is better to put the business’s profits to work making the business itself more valuable.
It simply means that a company can dispose their profits in two different ways: Disposal in the forms of dividend; and transferring the profits to reserve funds/retained earnings.
After making provision for bad and doubtful debts, depreciation of assets and all other matters which are usually provided for by bankers, the company may out of its net annual profits declare a dividend. In the process of making dividend decision a company generally consider following factors:
Considering these factors a company can take the decisions regarding dividend. A dividend is generally considered to be a cash payment issued to the holders of company stock. However, there are several types of dividends, some of which do not involve the payment of cash to shareholders. Some of these are:
Opposite to this, a company might choose to hoard its profit. This is especially true for businesses with cyclical sales and profits. For example, an airplane manufacturer might spend a lot of money one year building or upgrading a factory. It might lose money that year. In a couple of years, when the factory is making lots of planes and selling lots of planes, profits might go up, and so the company will prefer to save that money to buy the next factory.
Similarly, a company that plans to grow much larger might reinvest its profits back into the company so that it's worth more in the near future. You often see this in technology stocks, where acquiring more customers or increasing the value of each customer will hopefully produce even more revenue in the future—and more profits.
A company might also acquire other companies. This is similar to investing in the company. You can see this happen in very large companies, where it's cheaper and easier to buy an established but smaller company than it is to start a new line of business.
Added to these, a company may prefer to retain earning within the company due to the following reasons: