Page 298 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes There are many investment opportunities available for your cash surplus. You must
consider the advantages and disadvantages as well as the levels of risk, maturity, liquidity,
and the yields of each of your investment opportunities. The following are just a few of the
investment opportunities you may have:
(a) Checking accounts with interest

(b) Sweep accounts
(c) Treasury bills and notes
(d) Certificates of deposit (CDs) and money market funds

Risk in Investing Surplus

The investment of your cash surplus should never be speculative - that is, high risk. As in most
businesses, your cash surplus may only be a temporary surplus of cash inflows over your cash
outflows. Any permanent losses resulting from a high risk investment could be devastating,
even to the point of making you unable to continue your business.

The level of risk you are willing to accept ultimately determines the yield of your investment.
A higher level of risk will generally provide you with a higher yield. On the other hand, a low
level of risk will result in a lower yield on your investment. In some cases, you choose to invest
in an investment with a higher level of risk to gain a higher yield. But as a rule, a conservative
approach to the level of risk is recommended when investing your cash surplus.

Self Assessment

Fill in the blanks:
1. …………...is the amount of profit remaining after tax and distribution to stockholders that
is retained in a business.
2. The ability to use retained earnings wisely is a sign of ………….company management.
3. ……………mean net earnings available to equity shareholders from where a firm actually
declares dividends.

14.2 Dividend Policy

Since, management of earnings means allocation of earnings among dividends and plough of
profits. The term ‘dividend’ refers to that portion of company’s net earnings that is paid out to
the equity shareholders (not for preference shareholders, since they are entitled to have a fixed
rate of dividend). Dividend policy of a firm decides the portion of earnings is to be paid as
dividends to ordinary shareholders and the portion that is ploughed back in the firm for
investment purpose. The total net earnings of equity may be paid as dividends (100% dividend
payout ratio), which may consequently result in slower growth and lower market price or a part
of net earnings may be paid as dividends, higher capital gains and higher market price. When a
company uses a part of its net earnings for dividend payments then, the remaining earnings are
retained. Thus, there is an inverse relationship between retained earnings and payment of cash
dividend-the larger the cash dividends and lesser the retention, smaller the cash dividends and
larger retentions. Hence, the alternative use of net earnings or net profit dividends and retained
earnings are competitive and conflicting.
Dividend decision affects the value of the firm. The cash available for the payment of dividends
is affected by the firm’s investment decision, and financing decision. A decision, which is related

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