Meaning of Dividend
Dividend refer to the part of company profits that is distributed among its shareholders in proportion to the shares held by them. In simple terms, it is the amount of net earnings that company pay out to its shareholders. It is reward of shareholders for undertaking risks by investing their funds into business for making profits. Dividend is either distributed in the form of cash or stock by company. The amount of dividend to be paid out is dependent upon the profits generated by business. It is decided by board of directors when it is to be paid, in what proportion and in what form. Dividend payments are the indicator of strong performance and positive future of company. Ability of company to distribute stable dividends over a period of time reflects its good picture in market. It boosts the overall confidence of investors in future earning potentiality of company.
Types of Dividend
Various types of dividends are as discussed below: –
- Cash Dividend: Cash dividend is the amount of dividend that is paid in cash form by company. It is most common type of dividend paid out to shareholders. Board of directors announce the amount to be disbursed as dividend among shareholders on the “date of declaration”. Dividend is assigned to stock holder on “date of record” and finally the payments are made on “date of payment”. Companies need to be have adequate amount of cash and retained earnings for paying out cash dividend.
- Stock Dividend/Bonus shares: Stock dividend is one that is paid in the form of common shares by company among its stockholders rather than paying it in cash form. Whenever the company lacks operating cash, it issues additional shares to its existing shareholder in proportion to their shareholdings. Stockholders are not required to pay any extra amount for their respective bonus shares. Issue of bonus shares results in increase of company’s outstanding shares and also have positive psychological effects on investors.
- Scrip Dividend: Under this type of dividend payments, transferrable promissory notes with short maturity periods are issued to stockholders. These promissory notes denote promise by company to pay dividends at some future date and may or may not include interest amount. When company is short of liquidity and requires some time for converting its current assets into cash, it mostly issues scrip dividend.
- Bond Dividend: Bond dividend is also similar to scrip dividend under which promissory notes are issued. Main difference is that they carry longer period of maturity and bears interest.
- Property Dividend: Property dividend are paid to shareholders in the form of property instead of paying them in cash. Company declares non-monetary dividend to its stockholder in case of lack of operating cash. It may be issued in the form of asset, vehicle, real estate, inventory etc. Property given as dividend by company is recorded at fair market value as it may vary from book value. Difference in between the two values is recorded as a loss or gain.
Advantages of Dividend
Various advantages of dividend are as follows: –
- First advantage of dividend payments by company is that it boosts the confidence of investors. When dividend payouts are maintained over a long period of time, it acts as a sign of company stability. Investors become happier when get extra earnings either in cash or stock form as dividend serve as an important income source for them.
- Dividend is an important factor that is taken into consideration by investor before investing their funds. Companies who pays regular dividends to their stockholders are most likely to attract the various class of investors as compared to one that pays irregular dividend or no dividend.
- Another big advantage is that dividend income is treated as tax free income in many countries. Tax is deducted at source by companies itself on such incomes while distributing them to stockholders. The investor receiving such income do not need to pay any tax amount on it.
- Informational signaling is a very important concept in stock market. According to this concept, payment of dividends or issuing bonus shares are important source of providing signal to investors by company that it has a strong balance sheet. Every investor does not have much financial knowledge for understanding financial statements of company. Therefore, they will be happy if they will receive some benefits in the form of dividends and bonus shares.
Disadvantages of Dividend
- Major limitation is that companies runs out of cash by paying dividends among its stockholders. This amount could have been utilized for making investments in business leading to more growth. In this way, payment of dividends results in sacrifice of long term growth by company for short term benefits.
- Dividends are paid at the discretion of management. Companies are under no obligation to make such payments. Even if good profits are generated by company, management may decide not to declare any dividend.
- Companies when paying dividends need to pay tax on amount of profit they are willing to distribute among their stockholders. This way, dividend results in increasing the tax burden for company.