Dividends are an important aspect of owning a company's shares for many investors. Some investors develop dividend investing strategies, where they pick stocks based on if a company pays dividends and the value of those dividends. This allows investors to create a flow of income on top of the appreciation expected in the value of a stock. Investors choose stocks that pay robust dividends so that they can either keep the payout as earned income or use the income to reinvest in the company by buying additional shares, further increasing their dividend income stream.
Dividends are only distributed to shareholders when a company has met all of its financial obligations. A company can choose the remainder of earnings to be reinvested in the company or to be paid out as dividends. After dividends are paid out, the remainder of earnings, which are listed on the balance sheet, are retained earnings.
A useful metric in this scenario is the dividend payout ratio, which measures the dividends paid out in relation to the net income of a company. It helps provide insight into the amount of money being paid out as dividends versus the amount being reinvested in the company.
Dividends affect different areas of a company's financial statements. When cash dividends are paid out, the distribution affects a company's balance sheet in two primary ways: a decrease in shareholder's equity and a decrease in cash.
Accounting for Dividends
From an accounting point of view, shareholders' equity is decreased by the total dividend amount due to be paid on the declaration date, the date on which the board of directors decides that the company's dividend payment will be made to shareholders.
An offsetting "dividends payable" entry is made into the account on the same date. After the dividend amount is finally paid to shareholders, the dividend payable amount shown on the account is reversed and zeroed out as the obligation has now been met.
Cash dividends have no effect on a company's overall income statement. However, they do decrease shareholders' equity and the company's cash balance by the same amount. They do not impact the income statement because the value of retained earnings on the income statement is reported after the dividends have been paid out. The company's balance sheet size is reduced, as its assets and equity are reduced by the total amount paid out to shareholders in dividend payments.
After the Dividend
The company's cash balance is also decreased by a corresponding amount, as dividends payable are entered into the liability account. The entry is no longer present on the liability side of the company's balance sheet once the dividend payments to shareholders have been completed. There is no separate balance sheet account for dividends after they are paid on the declared payable date.
Cash dividends are the most popular type of dividend payment. However, some companies may offer stock dividends, where the company pays shareholders in shares of its stock instead of cash.
Shareholders may also have the option to reinvest their dividend earnings through a dividend reinvestment plan (DRIP). Some corporations allow shareholders to purchase additional shares from the proceeds of the cash dividend amounts due on the dividend payment date. A DRIP allows investors to often buy shares at a discount to the current share price.
Dividend dates can be some of the most confusing aspects of owning stocks and tracking companies. However, investors should take note of four important dates: the declaration date, the record date, the ex-dividend date, and the payment date.
The declaration date, as mentioned above, is the date a company's board decides to pay a dividend. The record date is the date by which investors must be registered with the company in order to become eligible for the upcoming dividend payment. Registration is usually automatic when a stock is purchased. The ex-dividend date is the date by which an investor must have held the shares to receive the dividend. It is usually two days before the record date. The payable date is the date on which the dividend is mailed out or deposited to clients' accounts.
The Bottom Line
Dividends are an important consideration for investors when choosing stocks, and they also impact a company's financial statement in a multitude of ways. Though dividends are not specifically shown in shareholder's equity, their impact flows through shareholder's equity as it reduces the shareholder's equity amount on the balance sheet.