Premium paid over par value (Paid-in capital in excess of par) 2,00,000 Retained earnings 1,40,000 Total shareholders

equity 4,40,000 In states where the firms legal capital is defined as the par value of the equity share, the firm could pay out Rs 3,40,000 (2,00,000+1,40,000) in cash dividends with out impairing its capital. In other states where the firms legal capital includes premium paid if any (all paid-in capital), the firm could pay out only 1,40,000 in cash dividends. An earnings requirement limiting the amount of dividends to the sum of the firms present and past earnings is sometimes imposed. In other words the firm cannot pay more in cash dividends than the sum of its most recent and past-retained earnings. However, the firm is not prohibited from paying more in dividends than its current earnings. Thus dividends can be paid only out of the profits earned during a financial year after providing for depreciation and after transferring to reserves such percentage of profits as prescribed by law. Due to inadequacy or absence of profits in any year, dividend may be paid out of the accumulated profits of the previous years. Dividends cannot be declared for past years for which the accounts have been closed. 2. Contractual constraints Often, the firms ability to pay cash dividends is constrained by restrictive provisions in a loan agreement. Generally, these constraints prohibit the payment of cash dividends until a certain level of earnings have been achieved, or they may limit dividends to a certain amount or a percentage of earnings. Constraints on dividends help to protect creditors from losses due to the firms insolvency. The violation of a contractual constraint is generally grounds for a demand of immediate payment by the funds supplier. 3. Internal constraints The firms ability to pay cash dividends is generally constrained by the amount of excess cash available rather than the level of retained

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