Most must have heard of dividends and interest, but not all of them know their actual meaning and the dissimilarities between them. Both of them are totally different in terms of concept. Dividends are the part of profits that the company distributes among its shareholders as a return for their investments. On the other hand, interests are the cost incurred on the funds it borrowed from its lenders. Business owners need to make sure that they passed the journal entries (Also see Journal Entries for Cost of Goods Sold) required to record these transactions in the books of accounts. If you are one of the business owners who do not know much about the accounting (Also see Reasons Why an Entrepreneur Should Hire an Accounting Firm) treatments associated with it, feel free to contact an accounting firm in Johor Bahru.
Dividends are part of the company’s profit that it distributes to its shareholders. Note that a company may have two types of shares, which are the preferred shares and common shares, thus two types of shareholders. The company needs to pay the preferred shareholders before they pay common shareholders as a dividend payment to the former is mandatory. In the case of the common shareholders, the company can decide whether it wants to pay them the dividends after it pays its creditors and preferred shareholders.
Interest, on the contrary, is the amount of money that a borrower needs to pay to his lenders as the lenders have allowed him to use the money that they have. Some may feel confused when it comes to interest because sometimes, they pay for it, but sometimes they receive it. If we look at this issue from a different perspective, when we save cash in the bank, it means that we let the bank use our money. This is why our bank savings accounts offer us interests.
Now, let us compare between dividends and interests so that we can understand their differences better. Dividends are part of the profits of a business that the company distributes to its shareholders. In contrast, interests refer to the charges that the borrower needs to pay his lenders for the money he borrowed. Hence, we can say that the former is a way the company gives some returns back to the shareholders who have invested in it, while the latter is the fees that someone should pay for using money that others own.
Besides, dividends are parts of the profit, while interests are payments that are charged against the company’s profit. Most companies will only distribute dividends when they make a profit; thus, the dividend payment is optional, except for the preferred shareholders. However, the company still needs to pay interests to its lender no matter whether it has earned a profit or has suffered from a loss.
Although dividend and interest are two different concepts, both are crucial in a business. The former helps to attract the shareholders to invest in a company so that it has enough funds to grow and develop. On the other hand, the latter plays a great role in helping a business to obtain greater financial (Also see Limitations of Financial Statements) leverage. Thus, both of them are crucial to increase the profitability and sustainability of a company in the long run.