Final answer:
The directors of a company must apply the solvency test before making distributions to shareholders, consisting of the profitability test and liquidity test, to ensure they only make distributions when there are adequate profits and the ability to pay debts.
Step-by-step explanation:
The test a company's directors must apply when making distributions to shareholders is known as the solvency test. This test has two parts. The first part is the profitability test, which requires that a company should only make a distribution if it has enough profits to justify the distribution. The second part is the liquidity test, which assesses whether the company will be able to pay its debts as they fall due after the distribution.
Directors are responsible for making certain decisions in a company owned by a large number of shareholders, which includes issuing stock, paying dividends, or reinvesting profits. These actions are governed by regulatory frameworks that may vary between private and public firms, with emphasis on protecting shareholder interests and ensuring the financial stability of the company.