Definition of Profit:

Profits . is the financial gain obtained by subtracting total expenses from total revenue in a given period. It serves as a key indicator of a business's financial success and viability.

Types of Profit:

1. Gross profit:

Definition: Gross profit represents the difference between total revenue and the cost of goods sold (COGS).

Calculation: Gross Profit =Total revenue – COGS

Significance:

Operational Efficiency: It highlights how efficiently a company produces and sells its products.

Margin Analysis: Examining gross profit margins helps assess the profitability of individual products or services.

2. Operating Profit (Operating Income):

Definition: Operating profit is the profit earned from a company's core business operations after deducting operating expenses.

Calculation: Operating profit = Gross profit - Operating profit

Significance:

Comprehensive Profitability: It offers a comprehensive view of a company's overall profitability.

Investor Perspective: Investors often focus on net profit as a key indicator of a company's financial health.

3. Net Profit::

Definition: Net profit is the final amount after subtracting all expenses, including taxes and interest, from total revenue.

Calculation: Net Profit = Operating Profit -Taxes – Interest

Significance:

Comprehensive Profitability: It offers a comprehensive view of a company's overall profitability.

Investor Perspective: Investors often focus on net profit as a key indicator of a company's financial health.

Ways of withdrawing from reserves and surplus:

1. Dividends

Dividends are a common method to withdraw reserves and surplus.

Dividends can be paid out of its profits without any restrictions. But if we are distributing the dividend from the reserves, we need to follow the conditions these are

1. Rate of dividend                                                           2. Total amount drawn                                                           3. balance of reserves

Pros & Cons of Distributing the dividend:

Pros:

Prosperous for Shareholders: Dividends provide direct financial returns to shareholders, attracting income-focused investors

Cons:

Impact on Capital Structure: It may impact the company's capital structure and potentially affect its financial ratios.

Tax Payments: the company declaring the dividend will have to deduct TDS under section 194 of the Income-tax Act, 1961. As per this section, 10% TDS is applicable for dividend income above Rs. 5000 for an individual

Taxpayers who are in 10% tax bracket as net cash flow in their hands will go up whereas for taxpayers in 20% tax bracket it will be neutral. But, taxpayers in 30% tax bracket will end up paying more tax to exchequer

2. Shares buyback

companies decide to purchase their own share from their existing shareholders either through a tender offer or through an open market.

Pros & Cons:

Pros:

Enhanced Share Value

Share buybacks can increase the value of existing shares by reducing the number of outstanding shares

Under Section 115QA of the Income Tax Act, any domestic company that buys back its own shares is liable to pay additional income tax on the distributed income at an effective tax rate of 23.296% of distributed income [Rate of tax - 20% (plus surcharge @ 12% plus Health and education cess @ 4%)]. This tax is known as ‘Buy-Back Tax’ or ‘Buy-Back Distribution Tax’ (BDT).

Cons:

Opportunity Cost: The funds used for buybacks could have been invested in growth opportunities or other strategic initiatives.

3. share Transfer

Meaning of Share Transfer:

Definition: Share transfer is the legal process by which the ownership of shares in a company is moved from one party (the transferor) to another party (the transferee).

Transferor: The current owner of the shares who wishes to sell or transfer them to someone else.

Transferee: The individual or entity acquiring the shares from the transferor

Pros & Cons:

Pros:

Liquidity for Shareholders: The withdrawal from reserves may provide liquidity for shareholders, especially if the majority shareholder is looking to realize value from their investment. Shareholders gain immediate access to funds without selling their shares on the open market.

Capital Gain Tax: When you transfer shares in a private limited company, it leads to capital gains income taxed under Income Tax Regulations. Startup investors exit by selling shares, and tax rates vary for short-term and long-term gains.

Cons:

Dilution Concerns: If the withdrawn funds are used for a share buyback, remaining shareholders might experience dilution. Dilution can lead to a reduction in ownership percentage and potentially voting power for existing shareholders.

Tax implications the methods mentioned above:

Notes:

Note 1.1:

Taxability of shareholders:

Note 1.2:

• For an understanding of Distributed income refer the below example
• ABC Ltd repurchases 1000 shares from the market with a market price of Rs. 500
• The issue price of the share is Rs 50
• Here distributed income is 450(Market price – issue price)
• Upon which the company needs to pay 20% tax that is Rs90 per share.