Cash Flow Considerations in respect of Profit Distribution
Use of Resources - Cash Flow Considerations
Building up adequate working capital is important, particularly if your business is expanding. If your business is growing, then stock, work in progress and debtors are likely to increase and you will be obliged to fund the increasing expenditure required by the business. The test of whether you need to retain profits for working capital is whether, after taking account of capital and borrowing facilities you have adequate cash resources to meet payments, e.g. salaries, suppliers and other creditors, without undue difficulty.
Where a company is effectively owned by its managers, you might need to consider whether surplus cash is best kept in the business for the acquisition of assets (and where it may be sheltered to some extent from taxation) or distributed to the owners. Shareholders will generally expect retained profits to generate a reasonable return when employed in the business. The directors ought to be able to demonstrate that they are providing a better return to shareholders by acquiring assets or otherwise using resources in the business than the shareholders would obtain elsewhere if the resources were distributed to them by way of dividends.
If you use surplus cash to acquire assets, you should consider the tax implications e.g. you may want to maximise the expenditure deductible from taxable profit in the year in question. You will also need to consider whether it is more economic for you to lease a particular asset or to use borrowed money to acquire it.