Unless you are actually managing a company in this fashion, I haven’t called any names at all.
It is bad business judgement for the simple reason that it follows no economic rationale as such.
Pay scale and expansion should be driven by market conditions, and if one is (for god knows what reason) mindlessly simply trying to avoid any taxation at all, one is rather likely to be escalating wages (assuming one is profitable) beyond sustainable levels. Notably unlike revenues, wages are sticky, so you can easily escalate wages up in a good run of say 2-3 years and then find a revenue drought of 2-3 that bankrupts you.
Of course if this is a small proprietorship, perhaps you can agree on wage cuts, but generally revenue services sniff out such naked scheming.
As for reinvesting of revenues, there is nothing wrong with that as such, but reinvesting in hard assets or regardless other business expansion to avoid tax as your motive again rather leads to expansive over expansion, likely at non-competitive costs, and when your real economic profits hit a drought - oh like say an economic downturn - you are well and truly fucked.
It is in short an utterly daft and incompetent way to run a business.
See Yahoo Finance, they have fine little tools for Americas at the least.
I would say that the places I see people managing vaguely in the manner you seem to be thinking are developing countries in Africa and Latin America, but then said firms are generally utterly fucked up and badly managed anyway.
Yes, there are some very simple reason why they should not do what you suggested.
If they do what you suggest, then they’ll be left with no money in the bank. Everyone who is able – whether human or corporation – needs to keep some money available just in case bad things happen. If sales go down, the corporation will be able to survive if they put away some savings. But if they have no savings, they can go bankrupt a lot faster. How much they need to hold in reserve will be determined by how much risk they’re willing to take.
Another reason to hold on to some profits is to save up for future purchases. Suppose this corporation has its eye on something really expensive that it would like to buy. It doesn’t matter whether we mean buying a new building, or buying a company, or whatever. Any kind of growth and expansion is going to be expensive, and it may be a lot smarter to save up for it for a few years than to finance it by borrowing.
There are many ways to be profitable. Minimizing taxes is only one of them. It seems to be the only one you thought of, but there are many others.
Also, unless I am severely mistaken, the only way the corporation can pay dividends to the stockholders is by making a profit.
If every last dollar gets reinvested in the corporation, they might successfully bring the tax bill down to zero, but the stockholders won’t be too happy about it.
The stockholders might WANT the corporation to reinvest a bit less than everything, specifically so that the corporation DOES declare a profit. Some of that profit will go to taxes, but the rest of it will go to the stockholders.
Hardly ever. Consumers should save rather than borrow to consume*, but companies don’t borrow to consume, they borrow to grow. The benefits of capital investment usually outweigh the costs of money. That’s why companies issue bonds to borrow money.
Two separate issues here: First, as has been mentioned, tax implications do not by themselves drive a company’s strategy. Second, reinvesting profit back into the company will not make the stockholders unhappy if it’s an established part of a company’s strategy. When they become stockholders, they know what the company’s strategy is and what they should expect. There is a tradeoff between paying out profit as dividends but having a stagnant stock price vs. no dividends but having the value of the company, and therefore the stock price, grow. When you invest in mutual funds you often have a choice of “growth” funds, which emphasize the latter, and “income” funds, which emphasize the former.
Neither one is good or bad, it just depends on your investment goals and how they line up with the companies’ goals. If you take profit in the form of dividends, you have to pay taxes on those dividends the year they are paid, at regular income rates. If the stock price rises, you don’t have to pay taxes on that growth until you sell the stock. Then you are paying at capital gains rates. Growth makes me happy
*Financial experts say that individuals shouldn’t borrow money to buy stuff unless it’s a necessity, generally a house or car. People borrow for things like televisions but that doesn’t enhance their ability to make more money. When a company builds a factory, they do it so they can make more money, more than what they pay in debt service.
You are mistaken. There is no need to generate a net profit in order to be able to pay dividends. For example, in 2008 Citibank had a net loss of $27.7 billion but paid out $7.5 billion in dividends.
No, dividends / distributions do not affect the income statement. They affect the stockholders’ equity portion of the balance sheet, the statement of stockholders’ equity, and the statement of cash flows.
As some other people have pointed out on this thread, net profit is not a very meaningful number.
In the wonderful world of bean-counters you have to distinguish between capital and expenses. Expenses are materials that get used up right away. Capital is assets of the corporation with a longer-term life. Expenses can be expensed right away - i.e. steel for making cars. Assets - new factory, new delivery truck - will have a multi-year life span.
For assets, you can only write off the expense as the asset is used up. Let’s say your truck has a 5-year useful life; you can write off (subtract it’s expense from income) only a certain amount (say, 1/5) every year. There are different formulas, as longa s they are reasonable and consistent. You can also subtract actual expenses like the interest on the loan to buy the truck or build the factory.
So you can have tons of cash, and spend it on “reinvestmetn” in the business, and the government will still consider you having a big profit. As you write off that asset over the next many years, you will actually have cash in the bank (paying yourself back for the money spent the first year) but after subtracting depreciation, you will not have a profit according to the acountants.
Oh, and another reason to borrow - companies that have huge cash or liquid assets become sitting ducks for takeovers. A&P and Greyhound, IIRC, were victims of this. they carried large inventories of downtown real estate (stores, bus stations) on the books at original 1930’s and 40’s value (the official accounting way to do it). Once bought and those assets sold off, they turned out to be much richer than the books said they were.
I’m not sure if this is clear or not, but for a gross simplification when a corporation’s taxable income (i.e. income minus expenses) is taxed, it’s probably only going to be about 25-30 cents on the dollar. I get the feeling that you think tax is at a high or near 100% rate or perhaps corporations are anti-tax activists?
e.g. Company has $1million in taxable income (i.e. after expenses) and pays $300k in tax leaving $700k of profit leftover.
So really, why throw away $1million on unnecessary expenditure when that could be $700k in the bank or a chunk paid to shareholders as dividends?
