Paying a Dividend from my company or Keep the Profits ?

‍Paying a dividend from my company is one of the most important decisions you’ll have to make about how to use your profits. Should you pay yourself a dividend, reinvest the money in the company, or do both? It’s a question that many business owners struggle with, and there’s no one-size-fits-all answer.

We argue that paying a dividend is an effective way to reward shareholders. Others believe that reinvesting profits is the key to long-term growth and success.

Lets explore the pros and cons of both options, so you can make an informed decision that’s right for your business.

Understanding Dividends and How They Work

First, let’s define a dividend. A dividend is a payment made by a company to its shareholders, typically in the form of cash, additional shares, or a loan account allocation. Dividends are paid out of a company’s profits and distributed regularly, typically quarterly or annually. There are various types of dividends, including regular dividends and special dividends.

Regular dividends are the most common type and are paid on a set schedule. Special dividends are one-time payments made by a company, typically when it has accumulated excess profits.

Stock dividends are paid in the form of additional shares of stock instead of cash not normally done for small mum and dad companies.

Not taking a Dividend is not good business planning . There have been many cases where retained earnings have become excessive, leading to poor tax-planning decisions because dividends have not been paid. 

Pros and Cons of Paying a Dividend to Shareholders

Now that we know what dividends are, let’s explore the advantages and disadvantages of paying dividends to shareholders.

Advantages of Paying  a Dividend

One of the main advantages of paying dividends is that it can be a great way to reward you as the owner. Shareholders receive a share of the company’s profits, and this can help to attract new investors and retain existing ones.

Importantly, paying a dividend reduces Retained Earnings. This reduction in retained earnings for a small business helps :

• The flow of profits for tax purposes
• The impact of holding excessive capital becomes apparent when the company faces a legal claim.

Disadvantages of Paying Dividends

One of the main disadvantages of paying dividends is that it can limit the company’s ability to reinvest in the business. When a company pays a dividend, it’s taking money out of the company that could be used to fund growth initiatives or invest in new projects. If the company doesn’t have enough cash to fund these initiatives, it may need to raise additional capital through debt or the owners lending money back. Another disadvantage of paying dividends is that it can create expectations among shareholders. If a company pays a dividend, shareholders may expect it to continue paying dividends.

Advantages and Disadvantages of Keeping Profits in the Company

Now, let’s explore the advantages and disadvantages of retaining profits within the company rather than paying dividends.

Advantages of Keeping Profits in the Company

One of the main advantages of retaining profits within the company is that it enables reinvestment in the business. By reinvesting profits, the company can fund growth initiatives, invest in new projects, and improve its products or services. This can help increase the company’s value over time and attract new investors.

Keeping profits in the company can also help to reduce the company’s reliance on external financing. If the company has sufficient cash to fund its growth initiatives, it may not need to raise additional capital through debt or equity. This can help to reduce the company’s debt load and improve its financial health.

Disadvantages of Keeping Profits in the Company

One of the main disadvantages of retaining profits within the company is that it can hinder profit distribution and extraction.

If the company doesn’t pay a dividend, shareholders won’t receive a share of the profits in the short term.

As the owner, this has two serious disadvantages

• NO reward in short term for your hard work
• Taxation – distributing in a regular method allows better tax planning
• Not declaring a divided but still taking the money may create a DIV 7a loan – not advisable

Another disadvantage of retaining profits within the company is that it can lead to excess cash that isn’t being used effectively. A business owner should have a clear plan for how to reinvest its profits. If not, it may be better to distribute profits to shareholders as a dividend.

Finally, take profits as you go and don’t leave it for someone else if something goes wrong, ie liquidation or legal action . Paying out dividends is like passing the gateway of no return. Be careful, though, as declaring a dividend with poor trading can lead to insolvent trading!

Criteria for Deciding Whether to Pay Dividends or Keep Profits

Let’s look at some criteria for deciding which option is best for your business.

Analysing the Financial Health of the Company

One important criterion for deciding whether to pay dividends or retain profits is the business’s financial health. If the company is financially stable and has excess cash, it may be a good idea to pay a dividend. However, if the company is in a growth phase and needs to reinvest profits to fund growth initiatives, it may be better to retain them internally.

Considering the Company’s Growth Potential

Another important criterion is the company’s growth potential. If the company has a high growth potential, it may be better to reinvest profits in the business. Thereby, funding growth. However, if the company doesn’t have many growth opportunities, it may be better to pay a dividend. Reward shareholders and extract the excess cash from the business.

Evaluating the Shareholders’ Preferences

Finally, it’s important to consider the preferences of the company’s shareholders. Some shareholders may prefer to receive a dividend, yet the other business owner may prefer to see the company reinvest profits in the business. It’s important to understand the preferences of the company’s shareholders and make a decision that’s in their best interests.

Consider the Franking account from a small business perspective and assess how it may affect your personal future tax liability. Remember, declaring a franked dividend has credits attached. However, while tax is paid with the lowering of the company tax rate, there may be top-up tax payable.

Top-up tax is effectively the shortfall of tax that may be incurred in the event that a shareholder is on a higher tax rate ie tax credits typically for small business is @ 25% but you may have taxpayers on higher rates such as 32.5% and beyon.d

SO WHAT TO DO –  Dividend vs. Profit Debate

The decision to pay a dividend or retain profits is complex and requires careful consideration of the company’s financial health, growth potential, and shareholder preferences.

While paying dividends can be a great way to reward shareholders and attract new investors, reinvesting profits can be the key to long-term growth and success.

Ultimately, the decision will depend on the unique circumstances of each business. This can be a discussion with an advisor like us. By weighing the pros and cons of each option and considering the criteria outlined above, business owners can make an informed decision that’s right for their company.