Dividends and Dividend Payment Procedure

When a company earns profit, it must decide how much to pay out to its shareholders and how much to keep inside the business for future growth. The part paid out is the dividend, and the policy that governs it is one of the three great financial decisions, alongside investment and financing. This chapter explains what a dividend is, the forms and schemes it takes, the procedure by which it is paid, and the factors that influence the decision.

Meaning, concept and forms of dividend

A dividend is the portion of a company's profit that is distributed to its shareholders as a return on their investment. Because shareholders are the owners of the company, the dividend is their reward for supplying risk capital. The decision on how much to distribute and how much to retain is the dividend decision, and it is guided by the balance between rewarding shareholders now and financing the firm's growth from retained earnings.

Dividends can take several forms:

• Cash dividend: the most common form, paid in cash out of the firm's earnings, which reduces both cash and retained earnings.
• Stock dividend (bonus share): additional shares given free to existing shareholders in proportion to their holdings, instead of cash. It capitalises reserves and increases the number of shares without paying out cash.
• Scrip dividend: a promissory note issued to shareholders promising to pay the dividend at a later date, used when the firm is short of cash.
• Property dividend: a dividend paid in the form of assets other than cash, which is rare.
• Stock split: although not strictly a dividend, a related action in which each existing share is divided into more shares of smaller face value, lowering the market price per share to make it more affordable.