What are the advantages and disadvantages of retained profits?


Quick Answer

The primary advantage of retained profits is that financial resources are used to reinvest in the company and create growth, according to the Houston Chronicle. A disadvantage of retained earnings is the loss that companies sustain, otherwise known as negative retained earnings. This negative balance carries over into the coming years, and it has the potential to lead to bankruptcy if the balance grows.

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Full Answer

The Houston Chronicle further notes that retained profits benefit companies when owners and managers are able to buy new equipment and pay off debts. The money also has the potential to be allocated to other areas, such as research and development and construction. The risk of losing money also comes with investment, because the purchasing price of the investments fluctuate daily.

The U.S. Internal Revenue Service allows certain companies to retain higher earnings. For instance, non-professional corporations are able to maintain earnings of $250,000 in retained profits each year, but doctors and lawyers operating as corporations are allowed to make $150,000 per year.

The Houston Chronicle indicates that higher retained earnings means having to pay more state and federal taxes, but there are tax breaks and depreciation deductions that allow companies to pay less in income taxes.

The Houston Chronicle claims that another disadvantage of retained profits is that companies cannot pay as many high dividends to shareholders. This is a disadvantage during economic times, since investors require higher dividends to minimize risk. Companies with higher retained profits attract more investors. Higher retained profits show investors that the company is doing well and eventually attracts more investment.

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