Untitled-29

(^330) Financial Management
Once a company has been formed and continues in operation, it should have earnings
to retain or to distribute to the owners. This disposition of these earnings is a fundamental
problem of financial management. In organisations, which are closely held, the problem
is not there because the shareholders run the organisation themselves and can dictate
the terms. In large organisations, however, the situation is different. Here the policy
concerning the distribution of earnings is normally delegated to the directors of the
company by the shareholders. However, they retain the final approval authority and the
dividend is paid only after final approval of the shareholders in the Annual General
Meeting. Once it is approved in the AGM, the dividend cheque is sent to the shareholders
within a month and is normally payable in the city of residence of the shareholder so as
to expedite the payment to him.
The management of an enterprise has an important financial decision to decide about
the disposition of income left after meeting all business expenses. Generally, of the total
business profits, a portion is retained for reinvestment in the business and rest is distributed
to shareholders as dividend.
Organisations finance a large portion of their needs internally, that is, from retained
earnings and from non-cash charges, such as depreciation, to the extent that they are
covered by earnings. To the extent that the organisations are dependent on internal
funds to meet their capital and other requirements, there could be a concern that the
funds retained may not be used as productively as they might be elsewhere. In a small
concern (especially proprietership/ partnership) the owners are very likely to compare
the return to be gained from retained earnings in the business and the return that they
might make from some other investment of equivalent risk. Because they do not
participate directly in formulating dividend policy, shareholders in large companies do
not have the chance to make this direct comparison. Thus earnings that are retained in
many companies have not met a "market test" and therefore we may not be sure that
they should have been retained.
The objective of the dividend policies should be to divert funds from the less productive
operations to more productive ones. But it is very difficult for the directors and the
management to accept the fate of a declining company and to allow the gradual liquidation
of their company, as would be suggested by economic thought. If the management
Chapter-12
Dividend Decisions