Starting and Running a Small Business For Canadians For Dummies All-in-One by Andrew Dagys

Author:Andrew Dagys [Buchaca, John]
Language: eng
Format: epub
ISBN: 9781119648413
Publisher: Wiley
Published: 2019-02-05T00:00:00+00:00

Why no cash distribution from profit?

In this chapter’s example, the business did not distribute any of its profit for the year to its owners. Distributions from profit by a business corporation are called dividends. (The total amount distributed is divided up among the shareholders, hence the term dividends.) Cash distributions from profit to owners are included in the third section of the statement of cash flows (refer to Figure 2-3). But in the example, the business did not make any cash distributions from profit — even though it earned $520,000 net income (refer to Figure 2-1). Why not?

The business realized $400,000 cash flow from its profit-making (operating) activities (refer to Figure 2-3). In most cases, this would be the upper limit on how much cash a business would distribute from profit to its owners. So you might very well ask whether the business should have distributed, say, at least half of its cash flow from profit, or $200,000, to its owners. If you owned 20 percent of the business’s ownership shares, you would have received 20 percent, or $40,000, of the distribution. But you got no cash return on your investment in the business. Your shares should be worth more because the profit for the year increased the company’s owners’ equity. But you did not see any of this increase in your wallet.

Deciding whether to make cash distributions from profit to shareholders is in the hands of the directors of a business corporation. Its shareowners elect the directors, and in theory the directors act in the best interests of the shareholders. Evidently the directors thought the business had better uses for the $400,000 cash flow from profit than distributing some of it to shareholders. Generally, the main reason for not making cash distributions from profit is to finance the business’s growth — to use all the cash flow from profit for expanding the assets needed by the business at the higher sales level. Ideally, the business’s directors would explain their decision not to distribute any money from profit to the shareholders. But, generally, no such comments are made in financial reports.

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