Question

Read the discussion questions below, select one, and post a comment of at least 150 words.

If a "typical" firm reports $20 million of retained earnings on its balance sheet, could its directors declare a $20 million cash dividend without any qualms whatsoever? Explain why or why not?

Answer 1

Retained earnings are defined as the cumulative net earnings of the company’s profits after accounting on the payment of dividends. It is also referred to as earning surplus that usually represents the reserve money that is available for reinvesting it back into the business.

In this case, the retained earnings of $20 can be fully utilized for dividend payments without any fear or confusion because the surplus can be distributed either fully or partially to the shareholders in the form of dividends. This can lead to earnings money going out of the books & accounts of the business forever because dividend payments are irreversible.

The decision to retain or fully distribute is left to the company’s management. But the decision is usually challenged by the shareholders through majority votes. But the management &shareholders usually like to retain the money for several reasons. In the long run, such initiatives may lead to better returns for the company shareholders instead of that gained from dividend payouts.

Most often, a balanced approach is taken by the company's management. It involves paying out a nominal amount of dividend and retaining a good portion of the earnings, which offers a win-win.