Question

'Sarah Ltd.' is a company manufacturing cotton yarn. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is the availability of enough cash in the company and good prospects for growth in future. It is a well-managed organisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments. It has taken a loan of Rs 40 lakhs from IDBI and is bound by certain restrictions on the payment of dividend according to the terms of loan agreement. The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company. Quoting the lines from the above discussion identify and explain any four such factors.

Answer 1

The decision which is discussed in the question is ‘dividend decision’.

Quotation for dividend decision: How much of the profits should be retained and how much has to be distributed by the company.

The following factors affect the dividend decision:]

1) Stable Earnings: A company with stable and smooth earnings can pay higher dividends to shareholders than a company which has unstable and uneven earnings.

Quotation for stable earnings: It has been consistently earning good profits for many years

2) Amount of Earning: A firm decides the dividends to be paid on the basis of its earnings. If the company has higher earnings, then it would be in a better position to pay dividends.As against this, if a company has low earnings, it would be able to pay lower dividends. 

Quotation for the amount of earnings: This year too, it has been able to generate enough profits.

3) Growth Prospects: Companies with higher growth prospects prefer to retain a greater portion of their earnings for future reinvestment. Accordingly, they pay lesser dividends

Quotation for growth prospects: There is an availability of enough cash in the company and
good prospects for growth in future.

4) Preference of Shareholders: The preference of shareholders must also be considered while taking dividend decisions. For instance, if the shareholders prefer that a certain minimum amount of dividends be paid, then the company may declare the same.

Quotation for preference of shareholders: It has many shareholders who prefer to receive a regular income from their investments.