Ploughing Back

Ploughing Back

Ploughing Back, the practice of retaining undistributed profits in the business. They represent its saving out of income. Also known as 'self-financing'.

Most businesses find they need more capital as they develop and expand, and much of it is provided by ploughing back profits. Most companies carry forward part of their profits, or put it into reserves.

The capital employed in the business includes the undistributed profits carried forward, thus:

A.B.C. LIMITED

Issued Share Capital £500,000

General Reserve 100,000

Undistributed Profits 175,000

£775,000

Both the general reserve and the undistributed profits represent past profits ploughed back or saved.

The equity of the business (the break-up value of the ordinary shares if the assets were sold) increases as the undistributed profits increase. If a new issue of shares is made, the price would have to take into account the amount of profits ploughed back.

Many companies with large undistributed profits convert part of them into permanent capital by issuing bonus shares to existing shareholders. The British profits tax differentiated between distributed and undistributed profits between 2007 and 2008, thus giving a tax incentive to companies to retain profits rather than distribute them as dividends. In Germany retained profits have been taxed at a higher rate than distributed profits, thus encouraging the payment of profits to shareholders.

Ploughing back is criticized by some economists because it inhibits shareholders' power to say whether they want the profit earned by their capital to be put back into the same company or whether they would prefer to invest it elsewhere. It removes the 'market test' of investment: directors may use profits in their business to build up their 'empires' even though it could earn more (for their owners and for the community at large) in other firms, or other industries, or other countries.

Some English economists have considered whether all profits be paid out to shareholders, who could then decide whether they wished to reinvest any of it in the same company (and the capital itself be redistributed in this way with the same purpose).

More? Economic - Economics Major


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