Many SME owners in Nigeria and across Africa treat a profitable year-end balance sheet as an automatic green light to distribute dividends to shareholders and founders.
However, neglecting a comprehensive numbers review before declaring dividend payments can trigger immediate liquidity crises, leaving businesses unable to fund daily operations.
In Nigeria, the commercial consequences of premature distributions extend beyond operational strain to severe legal liability.
Under the Companies and Allied Matters Act (CAMA) 2020, dividends may only be paid out of realizable, distributable profits, and directors can be held personally liable to refund the company if payments are made out of capital.
Retained earnings versus current paper profit
The first critical step in your financial assessment is checking your accumulated retained earnings on the balance sheet, rather than just the current year’s net income.
Net income represents your earnings over a single financial period, but retained earnings represent the cumulative profits kept in the business after accounting for past losses.
If your SME made a net profit of ₦15 million this year but carries ₦20 million in accumulated losses from previous years, your distributable profit remains negative.
Declaring a dividend in this scenario is illegal under Nigerian corporate law because it effectively pulls capital out of the company to pay shareholders.
Cash flow adequacy and the receivables trap
A business can be highly profitable on an accrual accounting basis while remaining severely cash-poor.
Paper profit includes trade receivables—money that customers owe your business but have not yet paid.
For example, a Lagos-based logistics firm might report a net profit of ₦40 million, but ₦30 million of that amount may be locked up in unpaid 90-day invoices from corporate clients.
Before declaring a dividend, management must calculate the Free Cash Flow (FCF), which represents operating cash flow minus necessary capital expenditures.
Paying dividends out of unpaid invoices forces the company to borrow expensive short-term overdrafts to cover basic operational expenses like payroll, taxes, and fuel.
Working capital and future capital expenditure
SMEs must evaluate their working capital ratio, specifically comparing current assets to current liabilities before making any distribution decisions.
A healthy current ratio of at least 1.5 to 2.0 ensures the business has enough liquid cushion to survive market fluctuations and delayed payments from customers.
Management should also project capital expenditure (CapEx) requirements for the next 12 months.
If your business needs to import new manufacturing equipment or upgrade its digital infrastructure next quarter, distributing cash today will stall that growth.
Before passing a board resolution to declare a dividend, request a comprehensive cash flow forecast alongside your profit and loss statement, and subtract your trade receivables older than 60 days from your available cash reserves to see if you can safely fund the payout.
