What is a dividend?

Dividend (definition)

A dividend is a portion of a company's earnings received by a shareholder. It’s a way for a business to distribute profits to its owners.

Dividend means divide – in this case, among shareholders. Companies are not obliged to pay a dividend. They must first have confidence in their financial position. The decision to issue a dividend sits with the board.

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Types of dividends

A dividend can be delivered in a number of ways, such as via cash payments, additional shares or even property. Cash is the most frequent type of dividend. The company will decide how much is paid per share. Shareholders collect that amount for each share they own.

Why do some companies issue dividends?

Many factors can affect a business's decision to issue dividends. A mature company with steady market share and reliable profits might pay dividends while a younger company may reinvest surplus cash into things that will grow the business.

Implications of issuing dividends

  • Funds are no longer available for operating expenses or capital investments
  • Recipients have to pay income tax on dividends
  • Extra reporting responsibilities, such as declaring dividends paid for tax verification

Dividends vs capital gains

Some investors value dividends as a form of steady income. They will put their cash into dividend-paying companies. Others value capital gains and may happily forego dividends if the business is successfully reinvesting its surplus cash into growth. The expectation is that growth will increase the value of the company and its shares. Investors can realise these gains when they eventually sell their shares.

The dividend payment process

Dividends are usually paid on a scheduled basis like quarterly or annually. Companies can issue interim dividends at any time during the year, while a final dividend is paid after the company's Annual General Meeting (AGM).The dividend payment process is typically steered by a company's board of directors.

How dividends are calculated

Dividend received = Dividend per share x Number of shares

To calculate annual dividends, add all dividends received during the year.

Calculating the dividend per share

When deciding how much to pay out, a company will consider many factors such as annual profits, the equity of the business, and budgeted expenditure for the upcoming year. Once an amount is agreed, it’s divided by the number of shares that exist.

Dividend calculation example

Waldo Manufacturing made a net after-tax profit of $10m and is retaining $5m for capital investments. They’ll distribute the remaining $5m as dividends across 100,000 shares.

$5m / 100,000

= $50 per share

The dividend per share is $50. So if you had 10 shares in the company, here’s how you’d work out your dividend:

Dividend received = Dividend per share x Number of shares

= $50 x 10

= 500

You would receive $500 in dividends.

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This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.