1.

Dividend policy
Once a company makes a profit , management must decide on what to do with those profits.
They could continue to retain the profits within the company, or they could pay out the profits to
the owners of the firm in the form of dividends. Once the company decides on whether to pay
dividends they may establish a somewhat permanent dividend policy, which may in turn impact
on investors and perceptions of the company in the financial markets. What they decide depends
on the situation of the company now and in the future. It also depends on the preferences of
investors and potential investors.

Dividend refers to the portion of net income paid out to shareholders. It is paid in cash and/or
stock for making investment and bearing risk. Dividend decision of the firm is yet another
crucial area of financial management as it affects shareholders wealth and value of the firm. The
percentage of earning paid out in the form of cash dividend is known as dividend payout ratio. A
company may retain some portion of its earnings to finance new investment. The percentage of
retained in the firm is called retention ratio. Dividend policy is an integral part of
the firm's financing decision as it provides internal financing. Dividend policy is concerned with
determining the proportion of firm's earnings to be distributed in the form of cash dividend and
the portion of earnings to be retained. A firm has three alternatives regarding the payment of
cash dividends:

1. It can distribute all of its earnings in the firm of cash dividends,

2. It can retain all of its earnings for reinvestment,
3. It can distribute a part of earnings as dividend and retain the rest for reinvestment purpose.

When dividends are paid to the stockholders the firm's cash is reduced. A firm may decrease its
dividend payout and use the retained funds to expand its capacity, to pay off some of its debt or
to increase investment. In this way, the firm's dividend policy is closely related with the
firm's investment and financing decisions. Determining the part of earnings to be distributed as
dividends is a key decision that affects the value of firm's common stock in the market place.
Similarly, the retained earnings are considered to be the most convenient internal source
available for financing corporate growth. Thus, every corporate firm should establish and
implement an effective dividend policy that leads the firm to stockholders wealth maximization.
It should be recognized that a firm's dividend payout ratio depends on many factors. For
example, it may be affected by the volatility in firm's cash flows and changing investment needs
over time. If the firm's cash flow is volatile, it may prefer to set a minimum level of regular cash
dividends that can be maintained even at low profits. Similarly, if the firm has profitable
investment opportunity it prefers to retain more amounts by reducing dividend payout ratio.

Dividend payment procedure

1. Declaration Date
Declaration date is the announcement that the company's board of directors approved the
payment of the dividend.

2. Ex-Dividend Date
The ex-dividend date is the date on which investors are cut off from receiving a dividend. If for
example, an investor purchases a stock on the ex-dividend date, that investor will not receive the
dividend. This date is two business days before the holder-of-record date. The ex-dividend date
is important as, from this date and forward, new stockholders will not receive the dividend. As a
result, the stock price of the company will be reflective of this. For example, on and after the ex-
dividend date, a stock most likely trade at lower price, as the stock price is adjusted for the
dividend that the new holder will not receive.

3. Holder-of-Record Date
The holder-of-record (owner-of-record) date is the date on which the stockholders who are to
receive the dividend are recognized.

4. Payment Date
Last is the payment date, the date on which the actual dividend is paid out to the stockholders of
record. Suppose Newco would like to pay a dividend to its shareholders. The company would
proceed as follows:
 On Jan 28, the company declares it will pay its regular dividend of $0.30 per share to
holders of record on Feb 27, with payment on Mar 17.
 The ex-dividend date for the dividend is Feb 23 (usually four days before of the holder-
of-record date). On Feb 23 new buyers do not have a right to the dividend.
  At the close of business on Feb 27, all holders of Newco's stock are recorded, and those
holders will receive the dividend.
 On Mar 17, the payment date, Newco mails the dividend checks to the holders of record.

Factors Affecting Dividend Policy

A firm's dividend policy is influenced by the large numbers of factors. Some factors affect the
amount of dividend and some factors affect types of dividend. The following are the some major
factors which influence the dividend policy of the firm.

1. Legal requirements
There is no legal compulsion on the part of a company to distribute dividend. However, there
certain condition imposed by law regarding the way dividend is distributed. Basically there are
three rules relating to dividend payments. They are the net profit rule, the capital impairment rule
and insolvency rule.

2. Firm's liquidity position

Dividend payout is also affected by firm's liquidity position. In spite of sufficient retained
earnings, the firm may not be able to pay cash dividend if the earnings are not held in cash.

3. Repayment need
A firm uses several forms of debt financing to meet its investment needs. These debt must be
repaid at the maturity. If the firm has to retain its profits for the purpose of repaying debt, the
dividend payment capacity reduces.

4. Expected rate of return

If a firm has relatively higher expected rate of return on the new investment, the firm prefers to
retain the earnings for reinvestment rather than distributing cash dividend.

5. Stability of earning
If a firm has relatively stable earnings, it is more likely to pay relatively larger dividend than a
firm with relatively fluctuating earnings.
6. Desire of control
When the needs for additional financing arise, the management of the firm may not prefer to
issue additional common stock because of the fear of dilution in control on management.
Therefore, a firm prefers to retain more earnings to satisfy additional financing need which
reduces dividend payment capacity.

7. Access to the capital market

If a firm has easy access to capital markets in raising additional financing, it does not require
more retained earnings. So a firm's dividend payment capacity becomes high.

8. Shareholder's individual tax situation

For a closely held company, stockholders prefer relatively lower cash dividend because of higher
tax to be paid on dividend income. The stockholders in higher personal tax bracket prefer capital
gain rather than dividend gains.

When dividend is paid out of profit it is called “profit dividend” and when it is paid out of capital
it is called “liquidation”. Usually there are 3 forms of dividend.

a) Cash dividend: it is the common method to pay the dividend. Here the shareholders get cash
in form of dividend but for this purpose the company must have adequate liquid resources.

b) Scrip or bond dividend: it is the promise made by the company to the shareholders to pay
them at future specific date. This form of payment is generally used in case the company doesn’t
have sufficient money.
c) Stock dividend: here the company issue bonus share to the existing shareholders. This form
of payment is also used in case the company doesn’t have sufficient money.

Receivable Management
Account receivable is the money receivable in some future date for the credit sale of goods and
services at present. These days, most business transactions are in credit. Most companies, when
they face competition, use credit sales as an important tool for sales promotion. As a sales
promotion tool, credit sale enhances firm's sales revenue and ultimately pushes up the
profitability. But after the credit sale has been made, the actual collection of cash may be delayed
for months. As these late payments stretch out over time, they may cause substantial drop in a
company's profit margin. Since the extension of credit involves both cost and benefits,
the firm's manager must be able to measure them to determine the ultimate effect of credits sales.
In this prospective, we define the receivable management as the aspect of a firm's current assets
management, which is concerned with determining optimum credit policy associated to a firm,
such that the benefit from extension of credit is greater than the cost of maintaining investment in
accounts receivables.

Significance and Purpose of Receivable Management

The basic purpose of firm's receivable management is to determine effective credit policy that
increases the efficiency of firm's credit and collection department and contributes to the
maximization of value of the firm. The specific purposes of receivable management are as
follows:

1. To evaluate the creditworthiness of customers before granting or extending the credit.

2. To minimize the cost of investment in receivables.
3. To minimize the possible bad debt losses.
4. To formulate the credit terms in such a way that results into maximization of sales
revenue and still maintaining minimum investment in receivables.
5. To minimize the cost of running credit and collection department.
6. To maintain a tradeoff between costs and benefits associated to credit policy.

Receivables, also termed as trade credit or debtors are component of current assets. When a firm
sells its product in credit, account receivables are created.

Credit policy

The discharge of the credit function in a company embraces a number of activities for which the
policies have to be clearly laid down. Such a step will ensure consistency in credit decisions and
actions. A credit policy thus, establishes guidelines that govern grant or reject credit to a
customer, what should be the level of credit granted to a customer etc. A credit policy can be said
to have a direct effect on the volume of investment a company desires to make in receivables. In
addition to specific industrial attributes like the trend of industry, pattern of demand, pace of
technology changes, factors like financial strength of a company, marketing organization, growth
of its product etc. also influence the credit policy of an enterprise. Certain considerations demand
greater attention while formulating the credit policy like a product of lower price should be sold
to customer bearing greater credit risk. Credit of smaller amounts results, in greater turnover of
credit collection. New customers should be least favored for large credit sales. The profit margin
of a company has direct relationship with the degree or risk.

The three important decisions variables of credit policy are:

1. Credit terms,
2. Credit standards, and
3. Collection policy.

Credit terms
Credit terms refer to the stipulations recognized by the firms for making credit sale of the goods
to its buyers. In other words, credit terms literally mean the terms of payments of the receivables.
A firm is required to consider various aspects of credit customers, approval of credit period,
acceptance of sales discounts, provisions regarding the instruments of security for credit to be
accepted are a few considerations which need due care and attention like the selection of credit
customers can be made on the basis of firms, capacity to absorb the bad debt losses during a
given period of time. Credit term is affected by the economic and nature of product, discounts
period, and cash discount. Credit term can be stated as “2/15 net 30”. It means that 2 percentage
discount is given if the bill is paid with before 15 days. The total credit period provided is 30
days.

Credit Standards

Credit standards refers to the minimum criteria adopted by a firm for the purpose of short listing
its customers for extension of credit during a period of time. Credit rating, credit reference,
average payments periods a quantitative basis for establishing and enforcing credit standards.
The nature of credit standard followed by a firm can be directly linked to changes in sales and
receivables. In the opinion of Van Home, "There is the cost of additional investment in
receivables, resulting from increased sales and a slower average collection period.
The quality of firm's customers largely depends upon credit standards. The quality of customers
can be discussed under

(i) Average Collection Period: It is the time taken by customers bearing credit obligation in
materializing payment. It is represented in terms of the number of days, for which the credit sales
remains outstanding. A longer collection period always enlarges the investment in receivables.

(ii) Default Rate: This can be expressed in terms of debt-losses to the proportion of uncontrolled
receivables. Default rate signifies the default risk i.e. profitability of customers failure to pay
back their credit obligation.
(iii) Character: Character means reputation of debtor for honest and fair dealings. It refers to the
free will or desire of a debtor of a firm to pay the amount of receivables within the stipulated
time i.e. credit period. In practice, the moral of customer is considered important in valuation of
credit. The character of customer losses its importance if the receivable is secured by way of
appropriate and adequate security.

(iv) Capacity: Capacity refers to the experience of the customers and his demonstratal ability to
operate successfully. It is the capacity particularly financial ability of a customer to borrow from
other sources in orders discharges his obligations to honors contract of the firm.

(v) Capital: Capital refers to the financial standing of a customer. Capital acts as a guarantee of
the customers' capacity to pay. But, it should be noted that a customer may be capable of paying
by means of borrowing even if his capital holding are scarce.
(vi) Collateral: Collaterals are the assets that a customer readily offers to the creditor (i.e. firm
granting credit) as a security, which should be possessed by the firm in the event 185 of non-
payment by the customer. A firm should be particular with regards to the real worth of assets
offered to it as collateral security

(vii) Conditions: Conditions refer to the prevailing economic and other conditions, which can
place their favorable or unfavorable impact on the ability of customer to pay.
Collection Policy

Collection policy refers to the procedures adopted by a firm (creditor) collect the amount of from
its debtors when such amount becomes due after the expiry of credit period. "A collection policy
should always emphasize promptness, regulating and systematization in collection efforts. It will
have a psychological effect upon the customers, in that; it will make them realize the obligation
of the seller towards the obligations granted. Credit policy of an enterprise shall be reviewed and
evaluated periodically and if necessary amendments shall be made to suit the changing
requirements of the business.

Control of receivable

Monitoring and controlling account receivable is a key task in credit management. Late
payments any be a sign of either intentional stretching or financial difficulties. So, overall level
of receivable is monitored to ensure sound collection procedure and to keys the credit function
inline. There are two important tools to monitor account receivables. They are:

- Days Sales Outstanding

- Aging schedules

Days Sales \outstanding

DSO is the average length of time required to collect the account receivables. It is the time
required to convert the receivables into cash. It is also known as Average Collection
Period(ACP) or Receivable Collection Period(RCP). DSO evaluates the efficiency of credit
management.

DSO = Receivable/ Credit sales Per Day

If firm offers the discount in credit term then some of credit customer pays within the discount
period. Some of them forego the discount and pay on final date.

DSO = % customer taking discount X Discount Period + % Customer paying in

time X credit period \+ % customer paying late X late period
Aging Schedule

Aging schedule is the technique used to evaluate the effect of credit term collection [policy and
DSO a firm can measure the efficiencies of collection department by using the aging schedule. It
include the age limit of receivables, amount of receivable, % of receivable of different age and
average age of each categories.

Meaning of Working Capital

Business organization requires adequate capital to establish business and operate their activities.
The total capital of a business can be classified as fixed capital and working capital. Fixed capital
is required for the purchase of fixed assets like building, land, machinery, furniture etc. Fixed
capital is invested for long period, therefore it is known as long-term capital. Similarly, the
capital, which is needed for investing in current assets, is called working capital.
The capital which is needed for the regular operation of business is called working capital.
Working capital is also called circulating capital or revolving capital or short-term capital.
Working capital is used for regular business activities like for the purchase of raw materials, for
the payment of wages, payment of rent and of other expenses. Working capital is kept in the
form of cash, debtors, raw materials inventory, stock of finished goods, bills receivable etc.

Concept of Working Capital

Generally, there are two concepts of working capital i.e. gross concept and net concept.

Gross working capital refers to the firm’s investment in the current assets and includes cash,
short term securities, debtors, bills receivables and inventories.

It is necessary to concentrate on the fact that the investment in the current assets should be
neither excessive nor inadequate.

Gross Working Capital = total current assets

Net working capital refers to the difference between the current assets and the current liabilities.
Current liabilities are those claims of outsiders, which are expected to mature for payment within
an accounting year and include creditors, bills payable, bank overdraft and outstanding expenses.
When current assets exceed current liabilities it is called Positive WC and when current liabilities
exceed current assets it is called Negative WC.

The Net WC being the difference between the current assets and current liabilities is a
qualitative concept. It indicates:

Working Capital Management

Working Capital Management is the process of planning and controlling the level and mix of
current assets of the firm as well as financing these assets. Specifically, Working Capital
Management requires financial managers to decide what quantities of cash, other liquid assets,
accounts receivables and inventories the firm will hold at any point of time.

The dangers of excessive working capital are as follows:

 It results in unnecessary accumulation of inventories. Thus the chances of inventory

mishandling, waste, theft and losses increase
 It is an indication of defective credit policy and slack collection period. Consequently
higher incidences of bad debts occur which adversely affects the profits.
 It makes the management complacent which degenerates into managerial inefficiency
 Tendencies of accumulating inventories to make speculative profits grow. This may tend
to make the dividend policy liberal and difficult to copes with in future when the firm is
unable to make speculative profits.

The dangers of inadequate working capital are as follows:

 It stagnates growth .It becomes difficult for the firms to undertake profitable projects for
non-availability of the WC funds.
 It becomes difficult to implement operating plans and achieve the firms profit targets
 Operating inefficiencies creep in when it becomes difficult even to meet day-to-day
commitments.
 Fixed assets are not efficiently utilized. Thus the rate of return on investment slumps.
 It renders the firm unable to avail attractive credit opportunities etc.
  The firm loses its reputation when it is not in position to honor its short-term obligations.
As a result the firm faces a tight credit terms.

It is a normal practice to maintain a current ratio of 2:1. Also, the quality of current assets is to
be considered while determining the current ratio. On the other hand a weak liquidity position
poses a threat to the solvency of the company and implies that it is unsafe and unsound. The Net
WC concept also covers the question of judicious mix of long term and short-term funds for
financing the current assets.

Permanent and variable working capital:

The minimum level of current assets required is referred to as permanent working capital and the
extra working capital needed to adapt to changing production and sales activity is called
temporary working capital. Working capital is the life blood and nerve center of business.
Working capital is very essential to maintain smooth running of a business. No business can run
successfully without an adequate amount of working capital. The main advantages or importance
of working capital are as follows:

1. Strengthen The Solvency

Working capital helps to operate the business smoothly without any financial problem for
making the payment of short-term liabilities. Purchase of raw materials and payment of salary,
wages and overhead can be made without any delay. Adequate working capital helps in
maintaining solvency of the business by providing uninterrupted flow of production.

2. Enhance Goodwill
Sufficient working capital enables a business concern to make prompt payments and hence helps
in creating and maintaining goodwill. Goodwill is enhanced because all current liabilities and
operating expenses are paid on time.

3. Easy Obtaining Loan

A firm having adequate working capital, high solvency and good credit rating can arrange loans
from banks and financial institutions in easy and favorable terms.
4. Regular Supply of Raw Material
Quick payment of credit purchase of raw materials ensures the regular supply of raw materials
from suppliers. Suppliers are satisfied by the payment on time. It ensures regular supply of raw
materials and continuous production.

5. Smooth Business Operation

Working capital is really a life blood of any business organization which maintains the firm in
well condition. Any day to day financial requirement can be met without any shortage of fund.
All expenses and current liabilities are paid on time.

6. Ability to Face Crisis

Adequate working capital enables a firm to face business crisis in emergencies such as
depression.

Factors Affecting Working Capital Management

Main factors affecting the working capital are as follows:

(1) Nature of Business:

The requirement of working capital depends on the nature of business. The nature of business is
usually of two types: Manufacturing Business and Trading Business. In the case of
manufacturing business it takes a lot of time in converting raw material into finished goods.
Therefore, capital remains invested for a long time in raw material, semi-finished goods and the
stocking of the finished goods. Consequently, more working capital is required. On the contrary,
in case of trading business the goods are sold immediately after purchasing or sometimes the sale
is affected even before the purchase itself. Therefore, very little working capital is required.
Moreover, in case of service businesses, the working capital is almost nil since there is nothing in
stock.

(2) Scale of Operations:

There is a direct link between the working capital and the scale of operations. In other words,
more working capital is required in case of big organisations while less working capital is needed
in case of small organisations.
(3) Business Cycle:
The need for the working capital is affected by various stages of the business cycle. During the
boom period, the demand of a product increases and sales also increase. Therefore, more
working capital is needed. On the contrary, during the period of depression, the demand declines
and it affects both the production and sales of goods. Therefore, in such a situation less working
capital is required.

(4) Seasonal Factors:

Some goods are demanded throughout the year while others have seasonal demand. Goods which
have uniform demand the whole year their production and sale are continuous. Consequently,
such enterprises need little working capital. On the other hand, some goods have seasonal
demand but the same are produced almost the whole year so that their supply is available readily
when demanded. Such enterprises have to maintain large stocks of raw material and finished
products and so they need large amount of working capital for this purpose. Woolen mills are a
good example of it.

(5) Production Cycle:

Production cycle means the time involved in converting raw material into finished product. The
longer this period, the more will be the time for which the capital remains blocked in raw
material and semi-manufactured products. Thus, more working capital will be needed. On the
contrary, where period of production cycle is little, less working capital will be needed.

(6) Credit Allowed:

Those enterprises which sell goods on cash payment basis need little working capital but those
who provide credit facilities to the customers need more working capital.

(7) Credit Availed:

If raw material and other inputs are easily available on credit, less working capital is needed. On
the contrary, if these things are not available on credit then to make cash payment quickly large
amount of working capital will be needed.
(8) Operating Efficiency:
Operating efficiency means efficiently completing the various business operations. Operating
efficiency of every organisation happens to be different. Some such examples are: (i) converting
raw material into finished goods at the earliest, (ii) selling the finished goods quickly, and (iii)
quickly getting payments from the debtors. A company which has a better operating efficiency
has to invest less in stock and the debtors.

Therefore, it requires less working capital, while the case is different in respect of companies
with less operating efficiency.

(9) Availability of Raw Material:

Availability of raw material also influences the amount of working capital. If the enterprise
makes use of such raw material which is available easily throughout the year, then less working
capital will be required, because there will be no need to stock it in large quantity. On the
contrary, if the enterprise makes use of such raw material which is available only in some
particular months of the year whereas for continuous production it is needed all the year round,
then large quantity of it will be stocked. Under the circumstances, more working capital will be
required.

(10) Growth Prospects:

Growth means the development of the scale of business operations (production, sales, etc.). The
organisations which have sufficient possibilities of growth require more working capital, while
the case is different in respect of companies with less growth prospects.

(11) Level of Competition:

High level of competition increases the need for more working capital. In order to face
competition, more stock is required for quick delivery and credit facility for a long period has to
be made available.

(12) Inflation:
Inflation means rise in prices. In such a situation more capital is required than before in order to
maintain the previous scale of production and sales. Therefore, with the increasing rate of
inflation, there is a corresponding increase in the working capital.
Profits are the difference between revenues and costs. In a trade transaction, profit is the
difference between the price at which you sell a good and the price at which you bought it.
Running a business, net profit is what is left out of turn-over after paying suppliers, workers,
financing institution, and the state. In insurance companies, it's the difference between the sums
of the premiums collected and the total claims resulting from insured negative shocks.
Distributed profits are the income source of the owners of business. As a social group, they are
called "owners" or "capitalists". The part of the value added not distributed as wages, interests,
and taxes, remain within the firm to finance investments.

Maximizing profits is said to be the objective of all firms. Indeed, it's not always easy for the
management to find out which are the right decisions that would maximize them. For instance,
short-run profits can be easily pumped up by avoiding maintenance, discretionary costs,
investments, that however are necessary of on-going competitiveness, as you can experiment
with this free business game. Moreover, what maximizes the "overall profits" is not necessary
what allows to attain the maximum of "profitability", i.e. the percentage of profits to turn-over,
as you can better understand by using this model of monopoly and comparing two policies: (i)
extremely high prices (= high profitability), (ii) a price set from a mark-up of 15% on costs.

In reality, firms do have profits targets, and sometimes they pay managers for reaching them,
but the goals of firms are broader than profits alone. Proceeding with other determinants of
profits, rising prices of competitors, better sales conditions and skills, a higher overall price level
allow for higher prices of the considered firm's products, thus increase nominal profits to the
extent that costs are inelastic, i.e. they rise less than proportionally to revenues.

Cost structure and its general elasticity to production level is thus relevant to profits. Economies
of scale increase profits more than proportionally when sales grow. Conversely, a recession with
falling sales levels will hit profits particularly hard in industries where there are economies of
scales and high fixed costs. Rising wages directly reduce profits. If, however, on a macro-
economic level, these wages will be spent on domestic goods, higher consumption will boost
business revenues, partially counteracting the previous dynamics. Depending on the dynamics of
exports and other GDP components, higher wages are compatible with higher profits, as you can
see in these real data.
In other terms, productivity gains determine rising profits.

High trade profits can prompt other people to entry the market and begin to compete with current
traders. In manufacture, this effect, although still present, crucially depends on the easy of
imitation of product features and production processes. It's often difficult to enter into highly
profitable markets. If markets were all perfectly competitive in their long run equilibrium, all
firms in the economy would have the same constant level of profits: zero. By contrast, in the real
world, firms have different profits with certain sectors and certain firms systematically reaching
better profits than others. This is due to ubiquitous imperfect competition, barriers to entry,
innovation and product differentiation.

Profits from process innovation

Consider the case of a competitive market where many firms sell basically the same product at
the same price. If they had the same technology and faced the same input prices (e.g. wages),
they would enjoy similar profit levels. Let's assume that one specialized supplier introduce a new
machine that is better than the state-of-art, say a faster machine. The suppler sells it to one of the
firms on the market. This will result in lower costs per unit of output, thus higher profits. These
profits are used, retrospectively, to pay for the investment in the new machine but after the pay-
back period they can be distributed to firm's owners.

The specialized supplier would like to sell again the new machine, either to its first adopter or to
its competitors. If not legally restrained, earlier or later, in fact, the competitors will pay attention
to the innovation and would like to imitate the first adopter. Slower or faster, innovation will
diffuse throughout the market. Possibly some of the reduced costs will reach the consumers in
terms of lower prices. If demand is elastic and there are economies of scale a self-sustained
positive feedback loop enlarges production capacity, production levels, profits and consumption.
If labour is not too weak, also wages will rise. In a certain point on time, firms that did not adopt
the new machine will see their profits seriously hit by competition and will have to choose
whether to exit the market, to adopt, or to find other competitive advantages. Pressure to reduce
wages in failing firms can be an example of these short-term defensive strategies.
Profits from product innovation

Consider a market with product differentiation, as this. An R&D investment over the years leads
to an improvement of one product features and the management decides to substitute this new
model to the existing one. Let's imagine for simplicity's sake that costs of product are the same as
the previous version.

Three main effects will increase sales:

1. consumers who did not buy the good because it did not satisfied their minimum requirements
on this feature can now buy, to the extend the improvement is sufficient at their eyes;

2. consumers who decides by a "top-quality" rule and positively value the feature could switch
from their current provider, to the extend the overall quality of the new good becomes superior;

3. consumers who decides by a "value-for-money" rule could switch from their current provider,
to the extend the price / quality relationships of the new good becomes more convenient.

At the same time, the price of this new version could be set higher than before, so that sales
would be broken, unit profits boosted. Overall profits would soar. Try all this - and the
consequences of competitors' reaction - by playing this business game.

Impact on other variables

Distributed profits go into the income flows of the owner, directly or as dividends. The expected
and actual rises in dividends boost the stock exchange quotations. Since shares are concentrated,
in their majority, in few hands, and the more so the ownership of private firms, the rich get
richer.

The demand pattern for consumption goods changes, with a more convex shape. There is an
increase in overall consumption quantities, especially of luxury goods, often leading to a more
than proportional growth of imports. In certain market segments prices rise.

Undistributed profits allows, and high rentability incentives, a new wave of investments,
partially funded by banks in this "euphoria tide" of positive animal spirits. Employment in
capital goods sectors, as well as in some correlated industries, rise as well. Actual workers can
ask for higher wages, credibly manacing strikes that would hurt profits, thus can encounter less-
than-usual resistance.

Taxation from profits and capital gains soars to give more funds to the State for spending and
balancing the budget. However, the rich and the very rich employ a vast array of sophisticated
techniques to exploit any loophole in the tax code to minimize their burden. In certain countries,
their interests are so protected by lobbies and political parties that the same tax code is written to
open such loopholes. Taxes on capital gains and profits can be lower than on labour; since the
rich have a disproportionally high share of income coming from the former, the effect is a
violation of "vertical equity" which requires that taxation be related to contribution capability.

Long-term trends

There is no long-term trend in profitability. Absolute profits rise with GDP. The share of profits
on value added depends on social groups compromises and conflicts. A certain tendence to a rise
of this share can be noticed in Western countries, without being an automatical consequence of
development or technology.

Behaviour during the business cycle

Profits are extremely pro-cyclical. At the early stages of recovery, inventories go down, with
sales surpassing production and injecting new liquidity to the business. The following increase in
production is obtained by a higher production utilization of plants and employment. Productivity
steeply rise and profits as well. During recovery and boom, employment and capital
accumulation (investments) can go hand in hand, increasing absolute profits if not profitability.

At the end of the boom phase, high interest rates on loans (taken for funding investment and
discretionary costs) hurt profits, as well as higher wages can do. Often unexpected, the demand
downturn make inventories piling up, freezing resources and forcing a fall in production. Before
this adjustment takes place, profits plunge even into negative values.

Experiment by yourself the inventory dynamics and how profits react to business cycle through
this dynamic monopoly model.