The dividend decision concerns the amount of profits that will be divided among shareholders. Whether all profits should be distributed, whether a portion of profits should be retained in the business, or whether a part should be retained in the business and the rest distributed among shareholders must be decided.
What is a Dividend Decision?
Dividend decisions refer to financial decisions in which part of the profits are distributed among the shareholders/owners of the corporation. This type of financial decision is known as a dividend decision. This means the company returns a profit to the stakeholders or the investors who have invested their capital in the firm. Decisions are made to distribute all the profit amongst the investors or retain some of it. This can ultimately boost the wealth of stakeholders.
Dividend Decisions Example
Assume that a person owns 100 shares in a particular firm or Company ABC. When the quarter ends, the company will evaluate and calculate its gross earnings. Then the Board of Directors will review the information of total revenues and decide an amount of dividend based on per share after that quarter.
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Types of Dividend Decisions
There are several types of dividends through which the companies pay a return to the stakeholders. Many of these are paid through cash, but in some types, cash is not involved. Here are some types of dividends:
1. Cash Dividend
A cash dividend refers to a payment made to shareholders as a result of the corporation’s current profits or their accumulated profits. Dividends paid out in this manner are called as cash dividends. This is the most common type of dividend that companies use.
In this type, the procedure that is followed initially starts from the date of declaration. On this date, the Board of Directors evaluates and decides the payment of dividend amount to the stakeholders holding the company’s shares.
Then, the dividend amount is assigned to all the shareholders holding the stock on the record date. After that, on the date of payment, dividend payments are issued to the investors.
2. Property Dividend
A property dividend is an alternative to cash dividends or stock dividends, where the company gives its shareholders a piece of property instead of cash or cash equivalents. This kind of dividend is known as a property dividend.
If a company does not want to make stock or cash payments, it can issue a non-monetary dividend to the stakeholders. The distribution should be recorded at the assets’ current market value, which might vary from the booking value of the assets.
This variance can lead to a gain or loss to the company. Sometimes, companies also use this method to alter reported or taxable income by issuing the property dividend.
3. Stock Dividend
The stock dividend can be defined as a dividend that is paid to shareholders in the form of shares of the company, opposed to cash. These dividends are known as stock dividends.
In this type, the company issues some common stocks without considering the common stakeholders. If the share is less than 25% of the previous one, it is considered the stock dividend.
If that amount is more significant than previous, pending shares, it is regarded as a stock split. Thus, the stakeholders get extra stock in the company as a return.
4. Liquidating Dividend
Liquidating dividends refer to payments made to shareholders during the process of partial liquidation or full liquidation. Such dividends are called liquidating dividends.
When the Board of Directors of a particular firm or company wishes to return the actual amount of capital invested, it is said to liquidate a dividend. This generally takes place when the company owner decides to shut down his business.
5. Scrip Dividend
Scrip dividends are new shares of an issuer’s stock that are sent to shareholders rather than dividends. This type of dividend is known as a scrip dividend.
In case a company does not have sufficient funds for issuing the dividend on a near date, they can issue a promissory note to issue them later. This might or might not include interest rates.
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Importance of Dividend Decisions
Here are some reasons why dividend decision is important:
As the dividends are taking the money out of the company, it would affect its share price. Here the dividend decision plays a crucial role in maintaining the share price. The share price may go down if the stakeholders own the share from the date of ex-dividend.
2. Maintaining balance
The firms need to balance the distribution of shares to stakeholders and the company’s growth. Dividend decision also helps to strike a proper balance between the wealth maximization and financing decisions for the long term.
3. Company’s reputation
In case the dividends are less, it can also affect the particular company’s market value. Proper and timely dividend payments show the firm’s maturity and business confidence that helps boost the company’s reputation. Conversely, if you pull the dividends, it might lead to fewer investors staying in your collaboration.
4. Extra income
Besides the firm, these decisions are equally important for the investors too. Many investors believe that a dividend is a source of additional income. This can be even more important for retirees who hold shares in a specific investment.
5. Modernization of firm
By the retained earnings of the dividends, a company can boost its growth and modernization.
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How do you Calculate Dividend Decisions?
Depending on their goals, the companies use different technical methods to calculate the dividend. However, here are some common methods:
Method of dividend yield
If a company wants to expand the base of shareholders by incrementing market capitalization, this is the ideal method to calculate dividends.
This method makes a comparison of dividends against the company’s stock price. Also, you can enhance the satisfaction of investors using this method as you will get a higher rate of dividend benefiting the shareholders.
The company would set a definite yield rate and, according to that, determine the actual payable amount.
Retention and growth rate
Many sectors such as tech and industries where a heavy infrastructure is oriented do not focus on the dividend policy. Here investors go for investing in getting a better capital appreciation.
Just because there is a low or less payment of dividends, so they are paid based on retention and growth rate. However, the main aim of these firms is to maintain steady growth.
Model of dividend discount and perpetuity
Finance is based on a basic fundamental concept that says the value of any asset remains equal to the cash flow’s present value. Generally, this method is used by companies who wish to have a healthy valuation via improving the prices of stocks.
When the company has a good evaluation, it attracts more stakeholders and has a good retention and growth rate.
What are the Issues in Dividend Decisions?
Several factors can affect and lead to issues in dividend decisions. Some of these are:
Type of firm
Firms with stable earnings can lead to better dividend policies than firms with uneven income flow. This can become an issue for the stakeholders and firm owners too.
Many times, the dividend decision is also affected by the shareholders’ types and desires. If they are financially stable, then you can manage them by paying the dividends accordingly. Still, if they are financially weaker, you will need to pay a dividend at regular timings.
The old Company does not require a large amount in stabilizing itself and saving for further development and growth so they can afford to pay dividends. On the other hand, newly established companies cannot afford to make such payments.
The taxation policy of the government can also create issues in making dividend decisions. This is so because the net earnings somewhat depend upon the taxation policy, which ultimately affects dividend decisions.
Frequently Asked Questions
What is the correct time to pay dividends?
Dividends can be paid at the end of the financial year. You can also play them at any time of the financial year as soon as the profits have been determined. Some companies also opt for quarterly payments.
A company must pay dividends according to the profitable investment chance. If you are not paying a good amount of dividends, you would have to face raising funds and capital for your company.
To answer this question, it is necessary to check the history of the company’s dividend payments. If a company makes regular and accurate dividends payments, it can have a higher share price than unstable dividend payments. Also, if a company has a stable source of earnings, then it can boost the impact of dividend decisions and enjoy higher share prices.
What are the effects of COVID-19 on the dividend policies?
When a firm is enjoying a happy time, it is easy to make dividend policies and payments effectively. However, if they are going through hard times, they will still maintain the dividend payments upright. However, nowadays, companies are cutting the dividends and investing or hoarding them into banks. As a consequence of COVID, companies are running towards security rather than profits.
Do stock dividends affect the equity of stakeholders?
No, there are no such effects of stock dividends on the equity of the stakeholders. As the stock dividend is the payment of common stock, the assets or liabilities of the firm do not affect the stakeholder’s equity.