A3.

2 Background of Dlvldond Pollcy

Profitabllty. growth and survival are the prime objectlves ot y bhustness
enterprisc. Growh and survival largely dependa on the proltabllty and thus, it can be
reated as the basls and key objecttve of businesa activitles. Iroltabtlity meusuren the
irm's ablity to carn the Ineone. All bustnesn Arms cndeavour to musimtNe thelr
profltabllity. The objective of maxtntsatlon of prolts ls crtttelsed by modern thtukers
and It is argued that firms should try to maxtmse thetr ability to caru more rolt
ather han to mmaximise proits.
Dividend Pollcy. as intlmately related to retadned carniugs, reters to the polley
coneerning the quantum of profts to be listributed as divilend. Thls Is probably lhe
most important single area of decislon-making for a flnaice manHger. Actlon tuken by
the management in this aren aflects tlhe grOwth rate of the company, its eredit stanlig,
share prlcing and ultimately the overall value of the company. An erroneous dlvklend
policy may land the company in Anancial precllcament and capltal structure of the
corporation may turn out unbalanced. Progress of the company may be lumstng
Oving to dearth of resources which nay result in all in carntngs per slre. Stoek
market is very likcly to react to this development and share prlces may lend to sg
leading to decline in total value of the firn. 1Extreme care and prudence on the part of
the policy framers is, therefore, necessary.
Meaning and Definition of Profit:
Proft may be defined as per Company LaIw. "as the nerease ln the net value of the
assets ofa business over their net value at the conmencement of a glven perlod which
has arisen other than by capital adjustment". In other words 'Proflt' can be deflned, "as
the amount of positive change in wealth resulting fronm business operations". Under this
EelinituOn. profits caii b deternined by measuring the amount of wealth at two p

ime. Usually.
ofascertained profits are determined through the accounting process
on a yearly basis. lt shouid be noted that the aforesaid definition of t and
capital profits.
considers both the profits-revenue profits as well as Revenue pro
business operations and indicate the
are the profits which arise out of
difference between sales and operating expenses. The profits
definition consider the liquidating concern' concept of the
defined in
the posia
afores
business and thus
include the unrealised profits.
The following definition of Income (income is the American version of proit
by the Committee on Accounting Concepts and Standards of the
Accounting Association, clarifies the concept of income or profit,
"he realised net income of an enterprise measures its effectiveness
on
Americc.
until and is the change in its net assets out of a) the excess or deficiency ofoperaing
re
conipared with expired cost, and b) other gains or losses to the enterprise from sal
exchange or
other conversion of assets
This definition clearly distinguishes between the revenue profit and capital
Part (a) describes the revenue profit vhich is derived not only prof:
out o operating expenses
paid il cash, but also out of outstanding eXpenses and amortisation of capital expense
through accounting adjustrments. Examnple, depreciatiorn, writing of
expenses, etc. The tern 'expired cost' in the miscellaneo:ug
definition refers to all such expenses,
Importance of Profit :
Periodic profit is an important information for all
The interests of the following factors are factors related to the business
diverse and conflicting. Therefore th:
declaration of the appropriate profit figures is of the utmost importance and provides
challer1ge to the accounting experts.
1) To the Owners
It indicates an increase in their wealth, and the
basis of dividend.
11) To the Management It measures the efficient utilisation of
funds. and
sufficiency of internal funds for expansion and
iüi) To the Creditors development.
It measures the safety of their funds and ability a
the company to service the debt (i.e. to pay
interest).
tv) To the Employees
It indicates security of emploVment and the abiy
of the company to pay fringe benefits.
To the Government
It decides the
vi) To prospectíve Investors
basis of tax revenue.
It indicates the trend of prospective earningS.
vi) To the Competitors It invites the entry of
Types of Profits : competitors.
The profit figure consists of the following
segnents :
Operating Proft : Operating profit arise out of sales minus operating
expenses including outstanding and amortised expenses.
 ) Non-operating Profts excluding Capital Profits : These arise out of
non-operating income (like interest dividend, etc.) ninus non-operating
expenses (like interest., etc.)
s#) Realised Capital Profits : Which arise out of profits on the sale of fixed assets
inestment etc. and 1ssue of shares, debentures, etc. at a premium.
Measurement of Profitability :
Proftability refers to the income generating ability of the investments. It is
Lesiured for the total investments in the business like return on investments (ROI) or
or a specific class of investments like return on equity capital (ROE). Thus, broadly, the
oroßtability of the business is measured on the following two basis
Retum on Investment (RO):
The profitability of the business measured on the basis of total fund invested in
the business. It is also known as return on capital employed. It is measured as
under :
Profits
KOI =Capital Emploved X100
the above formula, the profits and capital emnployed are taken in different ways
as under:
a) Profits may refer to any of the following figures
Operating profits or profit before interest and taxes (EPBIT).
ii) Net profits or Profits after taxes (PAT).
b) Capital employed may refer to any of the following two figures:
i Gross capital employed or total assets.
ii) Net capital employed or net fixed assets plus net working capital (i.e. current
assets less current liabilities).
2) Return on Equity Capital (ROE) :
The profitability of a business is also measured in relation to the risk capital
Provided by the equity shareholder. The ascerlainment of the ROE is important because
mth the use of financial leverage, (i.e. application of fixed-interest-bearing funds like
deDentures, preference shares, long-term loans, etc.) the ROE can be manipulated even
der the same ROI. This technique is also popularly known as 'trading on equity'.
KOE is ascertained with the help of the following ratio :
Profits available to Equity Shares x 100
Return on Equity (in %) Paid-up Equity Capital
ROE on per share basis popularly Profits available to Equity Shares
known as (Earning per share) Number of Equity Shares
rs data are widely used in practice, though the results derived under both the
Iormula are the same.
*"gure 4.9 shows the Flow Chart indicating the Process of Profit Planning.
 Business Finance
Budgets
Preparation ofVarious

Step

Oirect Material
Direct Labour OverheadandBudget inventory
Production Budget Administraive
Budgel
Sales Budget Budget Expense Budget

to be eslimated
Cost of Goods Sold

Income-Statement
|Preparation of Budgeted

Sheet
Preparation of a Projected Balance
Step 3

Assets, Liabilities and Capital

Efects of Planned Operalion on the

Step 4, Converting the Operation Profit Pian into Action

Proper folow-up is essential for Profit Planning

Fig. 4.9: Flow Chart indicating the Process of Profit Planning

Steps involved in the Preparation of aProfft Plan:
Profit Planning can be undertaken in the following steps : inventat
i) At first different budgets to sales, production, materials, labour,
overhead and administrative expenses are prepared. budgetedinc
Then the data of all the above budgets are consolidated into
statement. It mearns cost of goods sold to be estimated. etects
the
iü) Thereafter a budgeted Balance Sheet is prepared showing Compan,
planned operation on the assets, liabilities and capital of theperformance sh
iv) Finally,
be the asprofit
checked soonplan
as is put intoPoor
possible. operation. shouldof;
The quality
perforInance be corrected.
Important concepts related 'Dividend Policy': pollcywt
Following are certain important concepts which are related to
dividend
are summarised in Companies Act 1956.
i) Concept of Profit: bustn
bu tha
other
Profit nay be delined as the assets ofa
over their net value at the icrease in the net
value of the has arisenbeueen
.*

commencement of a given period

by capital
adjust1nent. In an accountant's view, the profit' iswhicn
the
difference
revenues and the expenses for a given period.
 Meaning of Divisible Proffts :
a11 the profits of the company cannot be said to be dlvisible. Only those profits
can legally be distributed to the shareholders of the company in the form of
dend are called as divisible profits. Accordlng to section 205, no dividend can be
Leclared or paid except out of profits of the company arrived at after providing for
depreclation or out of money's provided by the Central or State Government for the
oent of dividends in pursuance of a guarantee given by the Government. Thus.
dends may be declared only out of current profits, past reserves created out of
Drofits or credit balance the Profit and Loss Account brought forward and out of
enevs provided by the Government, if any. However, before declaring dividends,
Cection 205 (2A) requires that a company must transfer a prescribed percentage of its
nrofts (not exceeding 10%) to its reserves.
i) Dividend on Preference Shares:
The distinguishing feature of a preference share is that its holder is entitled to a
dividend of a fixed amount or at a fixed rate. The dividend on a preference share is
pavable before any dividend is pald on the ordinary shares. However, preference
dividend can be paid, only if the company has earned sufficient proits. In case
preference shares are cumulative, in the event of profits being insufficient in a
particular year to pay the preference dividend in full, the unpaid balance of the dividend
is carried forward and is payable out of the profts of later years. However. unpaid
preference dividend for the period preceding the winding up of a company are not
payable out of its assets in a winding up, even though the company has earned
sufficient profits to pay them, except where the dividends had been declared or where
the articles or terms of issue provide for such payment.
iv) Dividend on Equity Share :
Equity shareholders are entitled to be paid a dividend or their shares only after all
preference dividends have been paid to date. However, equity shareholders are
compensated in terms of, generally higher dividend and the voting power at general
meetings. The Articles of Association of companies generally contaln a provision to the
effect that directors shall recommend the dividends to be declared to the equity
shareholders and other shareholders In the general meeting (generally. annual general
meeting). Such meeting shall declare the final dividend. However, f articles so permit.
directors of a company may declare and pay interim dividend. Unlike final dividend
which cannot be revoked except under exceptional circumstances interim dividend may
be revoked. 'Interim dividend' does not constitute a statutory debt.
Unpaid and Unclaimed Dividends :
not
ere may be cases where a dividend has been declared by a company but has
been paid or unclaimed within 30 days from the date of the declaration to any
Shareholder entitled to the pavment of the dividend. In such a cases, section 205A
provides that the company shall within seven days from the date of expiry of the said
30days transfer the amnount of dividend which remains unpaid or unclaimed
 ano Sources of LTF
within the said period of 30 days to a special account. The
account must be opened t.
the cortpany in that behalf in any scheduled bank. In case of default in transferrine
unpaid of twelve percent per annum. Any amount transterred to the
unpaid dividen
account but remaining unpaid or unclaimed for a period of seven years from the date cf
such transfer must be transferred by the company to the Investor
Education and
Protection Fund. The amount credited to the said 'Fund' shall be utilised for promotuon
of investor's awareness and protection of the interests of investors in accordance with
the rules as may be prescribed. However, no payment shall be made to any investor in
respect of any of his claims.
vi) Payment of Dividend out of Capital :
Dividends are not allowed to be declared out of capital. Even where the
Memerandum or Articles give power to the company to pay dívidend out of capital, such
power shall be invalid. The only situation where a return on investment may be
allowed out of capital is where interest is paid out of capital, on the shares of the
company. with the previous approval of the Central Government under section 208.
vii) Payment of Dividend out of Capital Proffts :
The term capital profits' may be defined to mean those profits which arise
otherwise than in the normal course of the business. Example, profit on sale of fixed
assets, Capital profits may be realised profits or merely take the forn of book figures
created by such matters as revaluation. As per the decisions of the various Courts, in
this regard, the present position may be stated as follows :
Capital profits are not available for distribution as dividend unless.
a) the articles of association permit sucha distribution:
the surplus is realised; and
Cuch suplus remains after the valuation of whole of the
c) assets and liabilities
having been falrly taken.