• For expansion and growth of the business
• For strengthening the financial position of the company
• For meeting various working capital requirements of the company
• For redemption of old debts
• For replacement of obsolete assets and modernisation.

The amount of retained earnings in a company depends upon the following factors:-

• The amount of net profits is an important determinant of internal savings. Higher the net profits earned by a company, the greater is its capacity to plough back profits.
• The dividend policy of a company determines the extent to which the profits can be retained for reinvestment in the business. If a company follows a liberal and regular dividend policy, it may end up retaining lesser profits. But if it follows a conservative dividend policy, it has a chance of building up greater internal savings.
• Another factor is the rate of corporate tax imposed on the company. If the rate is high,then it may have lesser amount of internal savings.
• The age of a company also influences this amount. New companies are generally unable to retain much profits due to their desire to satisfy the shareholders. While the old companies may distribute smaller portion of their profits to shareholders and thus retain a larger amount of internal savings.
• The future plans of the company regarding modernisation and expansion also affects the amount of retained earnings.

Benefits of ploughing back of profits are:-

• A company with such reserves can face unforeseen contingencies; capital market crisis and other downturns in the economy with lesser difficulty and ease.
• Such reserves help to stabilise the dividend policy of the company. It thus helps in improving the company's relations with its shareholders. It even helps in appreciating the value of its shares.
• It is the most convenient and economical method of finance and involves no legal formalities or negotiations.
• It helps to keep the financial structure of the company fully flexible and even increases the credit-worthiness of the company.
• Growth and modernisation plans of a company will not suffer due to lack of finance, if the company has such retained earnings.

Thus, it is an important beneficial factor in the performance and growth of the company both in short and long term. But a policy of excessive ploughing back of profits may be disadvantageous for the company:-

• The heavy reinvestment of such profits,year after year, by a company may cause dissatisfaction among shareholders as they may get lower dividends.
• It may tempt the management to raise bonus shares to the equity shareholders leading to overcapitalization of reserves.
• The company may not always use the retained earnings to promote the interests of the shareholders. Instead,it may be invested in unprofitable avenues or misused by locking them up in those business concerns which are against the interests of the shareholders.
• It may be used to manipulate the share prices of stock exchange.The company may keep the dividend rate very low so as to purchase the shares at lower prices and later by increasing dividends rates,it may reap benefits from higher share prices.

In order to protect the interests of shareholders, the Companies Act contains rules regarding the payment of dividends by a company:-

• The rate of dividends are to be declared at the General Meeting and the rate recommended by the Board must be approved by the shareholders in this meeting. The three preliminary conditions for declaration of dividends are:-



• There must be profits
• The Board must recommend the distribution of profits as dividend;and
• The general body of shareholders must approve the Board's recommendations.



• The main sources of payment of dividends may be:-



• Current profits after providing for depreciation or
• Undistributed or accumulated profits of previous years or
• Out of both of the above or
• Moneys provided by the Central or State Government for payment of dividend in pursuance of a guarantee given by that Government.



• Before declaring dividends for any financial year,a certain prescribed percentage of profits will be transferred to the reserves of the company. The company may voluntarily transfer a higher percentage of net profits to reserve.
• If authorised by the articles,a company can pay dividend in proportion to amount paid up on each share.If there is no such provision in the articles,dividend shall be in proportion to the nominal value of the shares.
• Dividend is payable only in cash (or cheque) except where fully paid bonus shares are issued as per the articles,or it is adjusted towards outstanding calls on shareholding.The dividend warrant shall be sent to the registered address of the shareholder entitled to the payment of dividend.
• The dividend must be paid within 30 days of the declaration except:-



• Where there is dispute about the right to receive dividend
• Where it has been lawfully adjusted by the company against any outstanding due from the shareholder
• Where non-payment is due to certain directions given by the shareholder
• Where dividend could not be paid due to operation of any law or
• Where failure to pay dividend or post the dividend warrant within 30 days of declaration has been due to a fault on the part of the company.

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