Question

State the limitations of retained earnings.

Answer 1

The limitations of retained earnings are as follows :

1. There is imbalanced growth as undistributed profits remain in the same industry.

2. Since the profits of business fluctuate from time-to-time, it is an uncertain source of funds.

3. Excessive retained earnings causes dissatisfaction amongst the shareholders as this reduces the amount of the dividend receivable by them.

4. The frequent capitalisation of reserves may result in over capitalisation.

5. Many firms fail to recognise the opportunity cost associated with these funds. This results in the sub-optimal use of the funds.