Another appropriation of profits which has a hearing on working capital is dividend payment. The payment of dividend consumes cash resources and, thereby, affects working capital to that extent. Conversely, if the firm does not pay dividend the retains the profits, working capital increases. In planning working capital requirements, therefore, a basic question to be decided is whether profits will be retained or paid out to shareholders. In theory, a firm should retain profits to preserve cash resources and, at till same time, it must pay dividends to satisfy the expectations the investors. When profits are relatively small, the choice is between retention and payment. The choice must be made after taking into account all the relevant factors,
There are wide variations in industry practices as regards the interrelationship between working capital requirements and dividend payment. In some cases, shortage of working capital has been a powerful reason for reducing or even dividends in cash. They are occasions, on the other hand, when dividend payments are continued in spite of inadequate earnings in a particular year because of sound liquidity. Sometimes, the dilemma is resolved by the payment of bonus shares. They enables the payment of dividend without draining away the cash resources and, thus, without reducing working capital, Dividend policy, is thus, a significant element in determining the level of working capital in an organisation.