What is a Cash Dividend?

In simple words, it is a return (money) paid to the shareholders for the investment made in the organization’s shares. It is considered a reward to the investors after considering the firm’s prospects.

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.

Cash Dividend Chronology

There are some important dates that should be known around this concept of cash dividends

  • 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.
  • read more 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.read more 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.read more.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.read more 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.read more, payment must be made within 30 days of the AGM (Annual General Meeting).

Cash Dividend Example

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.read more 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

                                                                    = 3.33%

Let us understand the functioning of dates through cash dividend example:

  • On March 28, QPR company declared paying the regular cash dividend 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 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.read more.

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 = $12150 (shares) = $1,800Market Value post the event = $11.50150 = $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.

Importance of 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.read more 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.read more. 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.read more.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.read more 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.

Conclusion

The aspect of dividends 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, a comparison of cash dividends and dividend payout ratio should be compared amongst similar companies/industries.

Cash Dividend Video

This article has been a guide to what is Cash Dividends. Here we discuss cash dividends examples along with its importance and chronology. You may learn more about Accounting from the following articles –

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