As an investor, entrepreneur or even as someone aiming to be financially literate, one must know about Dividends, its types and implications as it is common source of additional income for many investors. Dividends are also considered as an important reflection of the company’s value as it is used in calculating the value of the stock in many methods. One can also determine the future yield or dividends estimates from historic data. Therefore, it is essential to know about dividends, from investor’s, management and entrepreneur’s perspective.
What is a Dividend?
A dividend is a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. A share of the after-tax profit of a company, distributed to its shareholders according to the number and class of shares held by them is called dividend.
The amount and timing of the dividend is decided by the board of directors, who also determine whether it is paid out of current earnings or the past earnings kept as reserve.
Dividend for Preference vs Equity shareholders
Holders of preference shares receive dividend at a pre-determined fixed rate and are paid first. But preference shareholders are not entitled to treat the preference dividend as debt and sue for its payment.
Holders of equity shares are entitled to receive any amount of dividend, based on the level of profit and the company’s need for cash for expansion or other purposes.
Dividend can be defined as the distribution of any sums to Members out of profits and wherever permitted out of free
reserves available for the purpose.
The right to claim dividend will only arise after a dividend is declared by the company in the General Meeting and until and unless it is so declared, the shareholder has no claim against the company in respect of it.
Types of Dividends
- Final Dividend
Dividend is said to be a final dividend if it is declared at the annual general meeting of the company. Final dividend once declared becomes a debt enforceable against the company. Final Dividend can be declared only if it is recommended by the Board of Directors of the Company in the Directors’ Report.
- Interim Dividend
Dividend is said to be an interim dividend, if it is declared by the Board of Directors between two annual general meetings of the company. All the provisions relating to the payment of dividend shall be applicable on the interim dividend also.
Dividends can tell us a lot about the company’s position. A deeper study of a company’s financial statements and dividends pay-out ratio (ratio of the dividend paid per share to earnings per share) can tell one about the company’s future plans as well.
For example, if the company chooses to retain most of its earnings and pay lesser dividends to its shareholders, it could possibly mean that it is planning to expand/grow by purchasing more machinery or opening another branch or outlet or introducing another product line. It could even mean that it is planning to invest in another company. This could increase the possibility of getting higher returns in the future. However, it is also riskier so investors with lesser risk appetite should sell their shares.
Hence, it is important to understand dividends and its implications in order to analyse the situation wisely and take decisions according to the risk appetite and wealth objectives of the investor. For the same reason, the management should also understand its implications to make sure the implications derived from company’s data and statements is in line with its future goals and objectives.
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