The ‘Ploughing Back of Profits‘ is a technique of financial management under which all profits of a company are not distributed amongst the shareholders as dividend, but a part of the profits is retained or reinvested in the company. This process of retaining profits year after year and their utilization in the business is also known as ploughing back of profits.
It is actually an economical step, which a company takes, in the sense, that instead of distributing the entire earnings by way of dividend, it keeps a certain percentage of profit to be re-introduced into the business for its development. Such a phenomenon is also known as ‘Self-Financing’,‘Internal Financing’, or ‘Inter- Financing’. A part of profits is ploughed back or re-employed into the business and is regarded as in ideal source of financing expansion and modernization schemes as there is no immediate pressure to pay a return on this portion of stockholders equity. Under this method, a part of total profits is transferred to various reserves such as General Reserve, Replacement Fund, Reserve Fund, and Reserve for Repairs and Renewals, etc. Sometimes ‘secret reserves’ are also created without the knowledge of the shareholders. From all the practices of financial management, this system of ploughing back of profits is considered desirable as it helps in the financial and economic stabilization of the concern.
The Necessity of Ploughing Back of profits
- The need for re-investment of retained earnings or ploughing back of profits arises for the following purposes:
- For the replacement of old assets, which have become obsolete.
- For the expansion and growth of the business.
- For contributing towards the fixed as well as the working capital needs of the company.
- For improving the efficiency of the plant and equipment.
- For making the company self-dependent of finance from outside sources.
- For redemption of loans and debentures.