Question

If a typical firm reports $20 million of retained earnings on its balance sheet, could its directors declare a $20 million cash dividend without having any qualms about what they were doing?

Answer 1

No.
Reasons are as follows:-

1. When a company earns profit in a financial year, it either can distribute it to share holders or can reinvest it in the business as retained earnings. So, The balance in retained earings represent reinvestment of earings over firm's life.

2. Retained earnings may include any unrealised gain. So, In this given case, $20 milion retain earnings may not be held as cash.

3. Paying cash dividend to Share holders is a financing activity. But Balance in retain earnings may be invested in firm's assets.