What is Dividend?

What is Dividend?

Dividend refers to the share of profit that a company distributes to its shareholders (Also see Do You Think Dividend is an Expense?). It is a return that the company’s shareholders obtain for making investments in that business. The board of the company will decide on the amount of distribution, and the shareholders will need to approve it. Then, the accountant will need to make necessary records in the financial statements. As this requires some knowledge and expertise in accounting, business owners are encouraged to hire an in-house accountant or an accounting firm in Johor Bahru to help them with this task.

You may have a lot of doubts in your mind right now: Where does that amount of money come from? How will the company pay the dividend to the shareholders? Generally, companies will manage the profits that it has earned in two different ways, which is to reinvest all the profits back into the company or distribute part of it to the company’s shareholders. The former is called the retained earnings, and the latter is the dividend distributed.

As soon as the company has settled its liabilities or has paid all its creditors, it can decide whether it wants to pay all or part of the profits to its shareholders in the form of a dividend. However, this is not a must, and the company may decide that it does not want to pay a dividend for the year. The company may pay dividends to its shareholders via buybacks (Also see Why Do Companies Repurchase Their Own Shares?), stocks and so on. Everyone who holds the company’s shares can receive the payments.

Most companies will pay the dividend in two forms, which are in cash dividend and stock dividend. The former is the most common, where the company will pay cash to the shareholders by transferring the sum of money to the shareholder’s account or by sending cheques to the shareholders. As against, stock dividend means that the company will issue additional share to its shareholders. Doing so increases the total capital the shareholders have invested (Also see Do You Know What is Paid-in Capital?). This brings benefits to both the company and the shareholders if the company performs well.

Dividends play a great role in maintaining the trust of the company’s shareholders by granting them returns for the money that they have invested. Also, companies need to pay a dividend to maintain the recurring nature of the business or to maintain financial ratios (Also see Financial Ratio Analysis). On the other hand, from the shareholder’s perspective, the dividends from the company invested can be one of the most important sources of income for them.

In short, dividends are crucial for a company as it can help in boosting the confidence and trust of the shareholders towards the company. However, distributing dividends means that the company needs to give up on the income that it could have invested in the business. Hence, companies should consider their future prospectus when deciding on the matters regarding the distribution of dividend.