Dividend Decisions and Importance

What is a dividend ? Why is it important ? What are the different dividend decisions ? Why are dividend decisions important in Financial Management ?   

What is a dividend?

Dividend is the part of the profit given to the shareholders in the form of cash or stock. It is a part of net income which is distributed to the shareholders on a per-share basis. Generally, a company may distribute the dividend to its shareholders after the creditors are paid. Not all the companies pay the dividend. Companies can skip the payment of dividends if there is a reinvestment plan or shortage of cash in the company.

The company’s board of directors determines the decision to pay the dividend, with the approval of its shareholders. After the announcement of the dividend distribution, the company sets the record date and all the eligible shareholders get the dividend as per their shareholding. Providing dividends is a strategic choice that the company needs to make based on different factors. 

Importance of Dividend

Dividend can have multiple implications. A company can best reflect its financial health and shareholder value through dividends. The regular payment of dividends can provide a strong message that the company is performing well and is fundamentally strong to invest in. The major importance of dividends is as follows

Signal of Financial Health

Constant dividend payment shows the company is generating enough cash and performing well. This signal can be beneficial to the company to attract more investors. Similarly, investors can assess a financially strong company and make informed investment decisions based on its dividend treatment.

Financial Planning

The dividend policy of the company shows the profit allocation in terms of dividends and retained earnings. This can support the long-term plan of the company related to growth strategies and strategic financial management. Similarly, dividends can be a source of income for some investors assisting them in their personal finance.

Equity Evaluation

Dividends can play a major role in equity investment and stock selection. Investors consider stock evaluation through dividends more reliable compared to other metrics like the price-to-earnings ratio. Similarly, a regular dividend is a good sign and suggests equity is doing well. Similarly, dividend yield metric helps investors to make informed decisions on which equity to choose for investment.

Tax Efficiency

A dividend option can help investors to save their earnings from high tax rates. Dividends are considered to be a steady source of income and they can be treated differently compared to other sources. Qualified dividends are taxed from 5% to 15% based upon the income and is considerably lower than other income tax.

Governments and regulatory bodies encourage individuals to invest in companies and become stockholders. Therefore, government tax dividend income at a lower rate than other forms of income as an encouragement.

Different Dividend Decisions

Dividend is not an obligation of any company. Companies may or may not decide to pay you the dividend. Therefore, companies choose different approaches for their dividend decisions. The dividend decision depends upon the company’s longer-term goals, financial situation, and shareholders’ desires. Most common dividend decisions are as follows

Stable Dividend

Stable decision is for conservative investors. Companies that follow this decision pay a fixed amount of dividends to shareholders regardless of the changes in company earnings. Shareholders get a stable source of income due to the fixed dividend rate. 

Residual Dividend

Companies that do not give priority to a predetermined dividend rate. Priority is given to financial obligations and investment plans then only to the dividend payout. The dividend is paid after other company expenses are covered. This means the dividend is based on the company’s financial performance. 

Constant Payout Ratio

Shareholders will get consistent dividend payout based on the earnings of the company. The company sets a fixed percentage from their earnings as dividends. In times of financial growth shareholders will get higher dividends and vice versa. 

Stock Dividend

Rather than giving cash as dividends, the company opts to provide shares as dividends instead of giving them as cash dividend. This will assist the shareholder to increase their ownership in the company. 

Companies decide to distribute stock dividend when they want to conserve cash for other purpose or other investment prospects.

No Dividend

Not all companies provide dividends to their shareholders. They choose to reinvest the profit back into their business.  The growing companies take this decision to utilize the future opportunities.

Dividend Decisions importance in Financial Management  

Financial management deals with the strategic planning and management of financial resources to achieve the goal of the company. Depending upon the size of the company, financial management seeks to improve the shareholder’s value, profit, and overall financial health of the company. The major aim of financial management is to make financial decisions that assist the stability and growth of the company. 

Dividend, being a part of profit, is also associated with financial management. The dividend is the percentage of reward allocated to the shareholders. Giving little dividends can cause shareholders to lose trust and confidence in the company. Similarly, allocating too much dividend can affect the cash converse of the company. So a balanced dividend needs to be allocated based upon the financial management of the company. 

The dividend policy reflects the intent of the company in the market. The frequent dividend payout shows a strong financial position and attracts potential investors. The financial aspects like debt payment and future growth plans are also shown by the dividend decisions. A company’s decision to hold the profit for reinvestment can also solve the problem of external borrowings and interest rates. 

Overall, a company’s dividend decision can aid in financial planning. It shows the company’s budgeting for dividends and retained earnings. The main objective of the dividend decision is to increase the company’s earnings. Dividend decision acts as a roadmap of funds utilization in the company. The dividend decisions are made based on factors like financial health, future growth, and shareholders’ expectations. A well-structured dividend policy provides information regarding frequency, timing, and amount of dividends. Some of the objectives of dividend policy like assuring investors’ confidence, capital allocation, tax implication, and signaling financial condition are important for financial management. 

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