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What is a 'Cash Dividend'

A cash dividend is money paid to stockholders, normally out of the corporation's current earnings or accumulated profits. All dividends must be declared by the board of directors, and they are taxable as income to the recipients.

Long-term investors who want to maximize their gains should consider reinvesting their dividends. Most brokers offer a choice to reinvest or take cash dividends.

BREAKING DOWN 'Cash Dividend'

Cash dividends are a common way for companies to return capital to their shareholders in the form of periodic cash payments, generally each quarter. While many firms pay regular dividends, there are special cash dividends that are distributed to shareholders after certain non-recurring events, such as legal settlements or borrowing money to make large one-time cash distributions. Each company establishes its own dividend policy and periodically assesses if a dividend cut or an increase is warranted. Cash dividends are paid on a per-share basis.

Timing of Cash Dividends

A company's board of directors announces a cash dividend on a declaration date, which entails paying a certain amount of money per common share. After that, a record date is established, which is the date on which a firm determines its shareholders on record. Also, stock exchanges or other appropriate securities organizations determine an ex-dividend date, which is typically two business days before the record date. An investor who bought common shares prior to the ex-dividend date is entitled to the announced cash dividend.

Characteristics of Dividend-Paying Companies

Companies that pay dividends typically enjoy stable cash flows, and their businesses are commonly beyond their growth stages. This partially explains why growth firms do not pay dividends; they need these funds to expand their operations, build factories and increase their personnel. Certain dividend-paying companies may go as far as establishing dividend payout targets, which are based on generated profits in a given year. For example, banks typically pay out a certain percentage of their profits in the form of cash dividends. If profits decline, dividend policy can be scrapped until better times.

Accounting for Cash Dividends

When a corporation declares a dividend, it debits its retained earnings and credits a liability account called dividend payable. On the date of payment, the company reverses the dividend payable with a debit entry and credits its cash account for the respective cash outflow. Cash dividends have no effect on a company's income statement. However, they shrink a company's shareholders' equity and cash balance by the same amount. Firms must report any cash dividend as payments at the financing activity section of their cash flow statement.

Comparing Cash Dividends Across Firms

The easiest way to compare cash dividends across companies is to look at trailing 12-month dividend yields, which are computed as a company's dividends per share for the most recent 12-month period divided by its current stock price. This standardizes the measure of cash dividends in relation to the price of a common share.

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