Analysis of Financial Statements_6

BONUS SHARES

Bonus shares are shares allotted by capitalization of the reserves and surplus of a corporate enterprise. Issue of bonus shares results in conversion of the company’s profits into share capital. It is, therefore also termed as capitalization of company’s profits. Such shares are issued to equity shareholders in proportion to their holdings of the equity share capital of the company.

Issue of bonus shares does not affect the total capital structure of the company. It is simply a capitalization of that portion of shareholders equity which is represented by reserves and surplus. It does not affect the total earnings of the shareholders.

Advantages of Issue of BONUS SHARES

1) Conservation of Cash: Issue of bonus shares makes it possible for the company to declare a dividend without using the cash resources that may be needed for operation or expansion. The company can thus retain earnings as well as satisfy the desire of the shareholders to receive dividend.

2) Wider marketability of company’s shares: Issue of bonus shares reduces the market price of company’s shares and thus keeps it within the reach of ordinary investors. In case of highly profitable companies, with decreased business, the earning per share tends to rise. In case this tendency unabated, market price of the company’s shares may touch a peak level which may scare away a large number of investors.

Advantages to Investors

1) Indication of higher future profits: Issue of bonus shares is generally an indication of higher future profits. This is because a company declares a bonus issue only when its earnings are expected to increase. In the absence of any such increase, the earning per share shall get diluted which is not desirable.

2) Increase in future dividends: The shareholder will get extra dividend in future as their shareholding base will get increased by the issue of bonus shares.

Sebi Guidelines

1) The bonus issue should be made out of free reserves built out of genuine profits or share premium collected in cash only.

2) Reserves created out of revaluation of fixed assets are not capitalized.

3) The bonus issue is not made unless the partly-paid shares are made fully-paid.