Debitoor's accounting dictionary

Dividends - What are dividends?

Dividends are payments made by a company from its profit to its shareholders, and are paid in proportion to the individual’s shareholding

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When a company is profitable at the end of the year, there are a number of options for the amount. It can be rolled back into the company, paid out in dividends to its shareholders, or both.

If shareholder payments is chosen, each shareholder will receive a dividend - a portion of the company's profit - in proportion to their shareholding. This is because dividends are allocated as a fixed amount per share held by the shareholder.

Why are dividends used?

Found mainly in larger businesses, dividends are used to provide shareholders with a portion of the profits made by the company.

Dividends can be issued only once, or they can be a regular, recurring payment stream to shareholders, and can be their main source of income. All shareholders must agree upon the terms and amounts issued for dividends beforehand.

Typically, dividends are used by companies in order to increase shareholder wealth, which serves to bolster the business, but is also preferable to shareholders in comparison to the less certain profit on capital gains. It is also not uncommon that dividends are treated to lighter taxation.

What dividends can signify

Once a dividend has been paid out, the price of the stock for that company should drop, as the dividends are paid out of the cash reserves.

The trend of dividend payments within a business might be an early signal of financial troubles or prosperity. For example, if a company that has regularly been paying out dividends suddenly cuts the policy, this could indicate that the profit has decreased and the money is needed for regular business operations.

Smaller businesses tend not to use dividends, as it is generally more important for most of the profits to be rolled back into the business and used in further development and growth.

Types of dividend payment

Dividends can be paid by a company to their shareholders in a number of different ways. These include:

  • Cash dividends: These are the most common type of dividend, and they are those paid out in the national currency of the firm, typically by electronic transfer or cheque. Cash dividends are usually taxable to the recipient in the year they are paid.
  • Stock dividends: These are dividends that are paid out in the form of additional shares of stock from the corporation, or a subsidiary corporation.
  • Property dividends: These dividends are paid out in the form of assets from the corporation.
  • Interim dividends: These are dividends which are made before a company's annual general meeting (AGM) and final financial statements are finalised.

Does the dividend amount matter?

Several prominent economists have argued that the dividend amount doesn’t matter as shareholders can easily sell or buy more stock to adjust the levels of their cash dividend. However, potential shareholders do consider the dividend policy of a company when looking to invest.

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