What Is Cash Dividend?
A cash dividend is that portion of the profit declared by the board of directors to be paid as dividends to the company’s shareholders in return for their investments done in the company and then discharging such dividend payment liability by paying cash or through bank transfer.
The cash dividend is paid out of the Net Profits made by the firm during the Financial Year. It is not mandatory for a company to declare dividends; instead, the amount can be plowed back for other developmental activities of the company. However, most established firms declare the dividends yearly or once in two years to keep the investors interested. The cash dividend is paid on a per-share basis.
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Cash Dividend Explained
Cash dividend per share are a payment that an entity gives to its stockholders out of the earnings in proportion to the number of shares held. This is a method that the organizations use to provide a return to the shareholders on their investments and, in a way, encourage them to invest more.
The aspect of cash dividend declared is considered a double-edged sword. On the one hand, providing the cash dividend to the shareholders does boost investors’ confidence. However, it involves financial resources foregone, which could be utilized for future developmental activities of the firm.
The stock market also may react accordingly. Initially, it may point southwards to the overall stock prices, but if a firm is known for distributing cash dividends, the stock prices may remain stable or rise to boost the stock market.
Hence, the decision on dividends has to be made, keeping in view the future positioning of the firm and the industry expectations it has set up. One should understand that Capital requirements and investor expectations vary from industry to industry. Thus, cash dividends and dividend payout ratios should be compared amongst similar companies/industries.
Simply put, it is a return (money) paid to the shareholders for the investment made in the organization’s shares. After considering the firm’s prospects, it is regarded as a reward to the investors.
Cash Dividend Explained in Video
The companies use a very simple way to calculate the dividend they wish to pay to the shareholders in the form of cash. It is as follows:
Cash dividend = Dividend per share x No of shares held by the shareholder.
The organizations declare the dividends which are on a per share basis. Thus, it becomes quite simple to calculate the amount for each stockholder.
There are some important dates that should be known around this concept of cash dividend declared.
- Declaration Date: The day when the Board of Directors of a companyBoard Of Directors Of A CompanyBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. announces the approval of dividend payment.
- Holder of Record Date: Record date of dividendRecord Date Of DividendThe date of record for dividends is the cut-off date decided by the top management for the investors to get registered as a stockholder in the company's books to get the dividend payment on their security holdings. is the day on which eligible stockholders are recognized.
- Ex-Dividend Date: The ex-Dividend Date is whereby investors are cut-off from receiving a dividend. It is normally two days before the holder of the record date. This date is very important because new shareholders are not eligible for dividends from this date onwards.
It is because the stock price tends to fall due to cash dividend payments.
- Cum Dividend Date: Period when the dividend has been declared by the firm but not paid. Stocks trade cum-dividend till the ex-dividend dateEx-dividend DateAn ex-dividend date is one of the four important dividend dates, usually set one business day before the record date. It is a deadline; shareholders need to buy the stocks before this date to become eligible for the upcoming dividend payout. It is also called the ex-date..
- Payment Date: The date on which the actual dividend is paid to the stockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares. of record. In the case of the interim dividend, payout happens within 30 days from the announcement date of the dividend, but for the final dividendFinal DividendThe final dividend is the sum allowed to the shareholders as announced in the company's annual general meeting after recording the complete financial statements and reporting the company's financial position and profitability to the Board of Directors in a given fiscal year., payment must be made within 30 days of the AGM (Annual General Meeting).
Let us take a simple example to understand the concept of cash dividend per share.
Let us assume PQR Company had substantially high profits for the current financial year and decided to distribute dividends to its shareholders. Mr’ C’ owns 150 shares bought at $15 per share, making his total investment $2,250.
If the firm declares a cash dividendDeclares A Cash DividendDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities. of $0.50 per share, Mr ‘C’ gets a total dividend of $75 ($150*$0.50). The yield on the same:
Total Dividend/Cost of the Stock = $75/$2,250
Let us understand the functioning of dates through cash dividend example:
- On March 28, QPR company declared paying the regular cash dividend distribution of $0.5 per share. It further mentions the holder of record date shall be April 27 and the payment date of May 20.
- The ex-dividend date will be April 25, indicating any new shareholders hereon are not eligible for the dividend. It covers up the T+2 aspect.
- The time frame between March 28 and April 24 is when the shares are trading cum dividend. If any new shareholder joins till April 24, they are eligible for a dividend facility.
- May 20 is the payment date on which QPR will dispatch the cheques to holders of record.
Extending the above example, the cash dividend distribution also has an inverse impact on the share prices. The stock price will generally fall post dividend declaration since it’s a fall in the equity value of the businessEquity Value Of The BusinessEquity Value, also known as market capitalization, is the sum-total of the values the shareholders have made available for the business and can be calculated by multiplying the market value per share by the total number of shares outstanding..
Let’s say if the price of the above stock was trading at $12 before the event and it the following date, it falls to $11.50. Assuming Mr’ C’ retains all the shares and there is no change in the Nominal value:
- The market value of the shares prior to the event = $12*150 (shares) = $1,800
- Market Value post the event = $11.50*150 = $1,725
As calculated above, the cash dividend received was $75, and the value of shares post the event was $1,725. When combined, it takes the total value to $1,800 ($1,725 + $75), which was the value of shares before this dividend. It implies that the share value decreases roughly around the same amount as the cash dividend.
Multiple factors impact the size and timings of dividends, especially in the aftermath of the 2008-09 Global Financial crisis.
- Firms may distribute cash dividends to maintain specific financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. or manage any cyclical tendencies. Let’s assume a firm is selling Air-Conditioners with high demand during the summer season. They may declare a dividend during the winter season, which will help maintain share prices. During winter, demand for such products dries up, and stock prices can tank.
- Firms in their maturity stage tend to pay regular dividends compared to the fast-growing firms as they are focussed on re-investing the cash for the growth of the business.
- Companies do not always pay dividends in cash and may pay stock dividendsStock DividendsA stock dividend refers to bonus shares paid to shareholders instead of cash. Companies resort to such dividends when there is a cash crunch. Shareholders are allotted a certain percentage of shareholding.. The shareholders may also be given a choice between cash and stock or permit the shareholders to buy additional shares with this dividend (dividend reinvestment plan)(dividend Reinvestment Plan)The dividend reinvestment plan is the option chosen by the investor to reinvest the amount of cash dividend payable by the company in new shares of the underlying securities on the date of dividend payment..
- Dividend yieldsDividend YieldsDividend yield ratio is the ratio of a company's current dividend to its current share price. It represents the potential return on investment for a given stock. display the overall sentiment of the market. Market experts observe the trend of cash dividend provided, and thus observations are made accordingly over a while, including periods of distress.
- The taxation laws of the respective country are to be considered before the declaration. Laws keep changing regularly, and thus, companies are required to adhere to them. Generally, firms must pay DDT (Dividend distribution tax) before distributing the same to the stockholders.
There are some limitations for this kind of dividend. Let us understand the details.
- The amount depends on the financial performance or strength of the company. The more financially strong and profits are high, the better will be dividend amount.
- Dividends paid out of the reserve will reduce it. Thus, the fund given out to shareholders will not be available for reinvestment of expansion of the business.
- The investors will expect to get regular cash dividend at regular intervals if the companies continue to pay so. This puts pressure on the management in case the performance is not good.
- Since the cash dividends are taxable, it reduces the overall returns that the shareholders will get on their investment. Thus, the tax implication has a negative impact even though the dividends are desired.
- It becomes difficult to hold the positive mindset of the investors if due to some reason the company is not able to pay the dividend. Unexpected reduction in the amount of changes in the policy affects the stock prices.
It is important for every company to understand the pros and cons of paying regular cash dividend to its shareholders because the fund once paid, cannot be taken back and is no longer available for internal purpose.
Cash Dividend Vs Stock Dividend
Both the above methods are two different ways to give back the profits earned by the entity to its shareholders as return. However, there are some differences between them as follows.
- The former is a payment in the form of cash and the latter is payment through distribution of additional shares.
- In the former, the stockholders get a fixed sum of money as payment from the company which is in a certain proportion to the number of stocks that they own, whereas for the latter the stockholders gets stocks instead of money which is also in a certain proportion to the number of stock they already hold.
- The method of payment is different for both. In case the dividend is in the cash form, payment is either transferred to the bank account directly of credited to the brokerage account. But in case of stock dividend, the shares are transferred to the brokerage account.
- The number of shares that the investor holds do not change due to dividend paid in the form of cash, but stock dividend increases the number of shares that the investor holds.
- Regarding the tax treatment, the cash dividend is taxable whereas stocks dividend are not, unless the stock are sold.
Thus the management or the board of directors have to decide whether the business will pay cash or stock dividend to the investors and the decision depends on many factors. The financial strength, shareholder preference, etc are some of them.Regarding the tax treatment, the cash dividend is taxable whereas stocks dividend are not, unless the stock are sold.
This article has been a guide to what is Cash Dividend. We explain differences with stock dividend, along with formula, example, chronology, importance & limitation. You may learn more about Accounting from the following articles –