1. avatar says

    @johnmoffat – Hi John, excellent lecture as always. Thank you

    Can you clarify point 3? I thought dividends were an appropriation of profit, and as such the retained earnings belonged to the shareholder whether it got paid out as dividend or not.

    So, by paining lower divvies, the retained earnings would just grow and grow as a credit on the balance sheet (sorry SoFP), and in order for the company to get its mitts on the retained earnings they would need to issue bonus shares to the shareholders in return. Is that right, or should I put F7 behind me while doing F9?
    Thank you

    • Profile photo of John Moffat says

      It is true that the retained earnings (and therefore the total long-term capital) would grow and grow.
      But think how the Statement of financial position balances – more long term capital means more net assets!

      Of think of it this way – if a company pays out all its earning as dividends then they have no cash left to invest. If they restrict the dividend they have cash left over which can be used to invest in expanding the company.

      (Issuing bonus shares makes no difference – they would get no extra cash, and the total capital would remain unchanged as well (more share capital but less retained earnings).)

      I think you have probably got it by now, but in case not:

      Suppose a company is entirely cash based (for ease), and has cash of 100,000 and share capital of 100,000.
      They make a profit of 10,000.
      So… is 110,000; sh cap + ret earnings 110,000
      If they pay a dividend of 10,000, then back to cash of 100,000 and sh cap of 100,000

      If on the other hand they only pay dividend of 2,000 (and retain 8,000), then cash is 108,000 and sh cap + reserves are 108,000.

      The more of shareholders money that they retain, the more cash they have available to invest.

      • avatar says

        Hi John,
        Thank you for the answer.
        so, just to clarify,
        In the above example where they paid 2,000 they’d have 108,000 to invest
        Retained earnings will still be 8,000 even if they used the cash to invest.

        So, assuming they made 12,000 profit the following year retained earnings would be 20,000. Using the cash doesn’t actually reduce the equity in the business does it?

        Thank you

Leave a Reply