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Ploughing back of Profits - Advantages and Disadvantages

Ploughing back of Profits - Advantages and Disadvantages
Ploughing back of Profits - Advantages and Disadvantages

Q. What is meant by “Ploughing back of Profits”? Discuss the advantages and disadvantages of the policy of Ploughing back of profit.
Answer: Ploughing back of profit means the use of profits of the business for its development. Ploughing back of profits is a useful source of getting extra capital for building and expansion of business. As stable مستحکم company invests a certain percentage of profits into business. This process of retaining profits into business is called ploughing back of profits.
NEED OF PLOUGHING BACK: The need for ploughing back of profits arises for the following reasons:
a)     Replacement of old machinery
b)    Modernization of machinery and equipment
c)     Expansion and growth of machinery
d)    Meeting long and medium terms needs of business
e)     Redemption واپسی  of loans and debentures
The main advantages of ploughing back of profits to a company, shareholders and society are as under:
(A) ADVANTAGES To A COMPANY: Following are the advantages for the company
1) Shock Absorber: In a period of depression مایوسی, the part of profits reinvested in business act as shock absorber. The company can easily face the shocks of ups and downs of business cycles.
2) Aids in Smooth Running: This self-financing method aids in the smooth running of the business.
3) Increase Credit Worthiness صلاحیت: A company which reinvests a part of profits every year into the business is considered a stable company. As such it increases the credit worthiness of the company.
4) Self Dependent خود مختارCompany: A company which retains a part of profits becomes self-dependent to a great extent. It depends less on outsider agencies for financial help.
5) Expansion and Growth: The company with retained earnings can spend funds for expansion, modernization, replacement of machinery, etc. easily for business.
6) Redemption of Long Term Debts: A company which re-employs a part of profits into business is generally able to pay back its long term loans easily.
(B) ADVANTAGES To Shareholders: Following are the advantages for the shareholders.
1) Increase in the value of Shares: A company which earns profits and reinvests a part of it into business every year is considered a stable company. It earns a good name. As such the value of its shares rises in the share market.
2) Increase in Earning Capacity: The retained earnings in the business helps the company to grow. It increases the earning capacity of the concern.
3) Retaining the Control: A self-financing company no need to issue new shares for its future capital requirements. This enables the existing shareholders to retain the control of the company.
(C) ADVANTAGES to Society: Following are the advantages for the society.
1) Increase in the Rate of Capital Formation: The retained earnings in a business lead to expansion and growth of business. The rate of capital formation increases in the country.
2) Rapid Industrialization: The ploughing back of profits into business stimulates ابھارناindustrialization in the country. The nation as a whole, thus benefits from it.
3) Increase in Industrial Capacity: The reinvestment of profits in the business meets a part of the fixed and working needs of the company. The modernization and rationalization increase industrial production.
4) Better Quality of Goods at Reduced Prices: The retained earnings in business increases productivity, reduces costs, provided more jobs to the workers, leads to increase in their wages, etc. The industries are able to produce better quality of goods at cheaper cost.
The followings are disadvantages of ploughing back of profits.
1) Overcapitalization: If there is excessive ploughing back of profits, it may lead to overcapitalization of the company. The company may not be able to pay a fair rate of dividend to its shareholders.
2) Reduced Dividend: The reinvestment of profits reduces the amount of dividend payable to shareholders.
3) Evasion بچت of Taxes: A company may retain earnings with the sole object of evasion of super profit tax. Such evasion of taxes reduces the revenue of the government.
4) Frustration مایوسی among Shareholders: If there is too much ploughing back of profits into business, it creates dissatisfaction and frustration among shareholders.

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