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Distributions from profit by a business C corporation (see Chapter 5 to understand the different forms of business legal entities) are called dividends (because the total amount distributed is divided up among the stockholders). Cash distributions from profit to owners are included in the final section of the statement of cash flows (refer to Figure 2-3). In our example, the business made a cash distribution in the form of a dividend from profit of $400,000 — even though it earned $4.482 million of net income (see Figure 2-1), or just 8.9 percent of profits. Why so low?

It’s clear that the company has plenty of cash available to issue a dividend, as not only did it generate $4.482 million in net profit, but it also generated another $3.111 million in cash from non-cash expenses and operating activities ($1.739 million plus $1.372 million; see Figure 2-3). Should the business have distributed, say, at least half of its cash flow from profit, or roughly $3.8 million, to its owners? If you owned 20 percent of the ownership shares of the business, you would have received 20 percent, or roughly $760,000, of the dividend. But you got almost no cash return on your investment in the business. Your shares should be worth more because the profit for the year increased the company’s owners’ equity, but you didn’t see any of this increase in your wallet.

Deciding whether to make cash distributions from profit to shareowners is in the hands of the directors of a business corporation. Its shareowners elect the directors, and in theory the directors act in the best interests of the shareowners. So, evidently, the directors thought the business had better use for the $3.8 million cash flow from profit than distributing some of it to shareowners. In our example, the company does indeed have something big planned for the use of its cash hoard of $11.281 million, as it has earmarked funds to support buying a complimentary business in future years. Generally, the main reason for not making cash distributions from profit is to finance the growth of the business — to use all the cash flow from profit for expanding the assets needed by the business at the higher sales level (which is the case here). Ideally, the directors of the business would explain their decision not to distribute any money from profit to the shareowners. But generally, no such comments are made in financial reports.