In the earlier lessons you have learnt about the various financial decisions to be made by you as a financial manager in respect of financial structure and the cost of capital. In this lesson you will understand that how dividend decisions will affect the financial decision. Various forms of dividends are necessarily known by you to take proper dividend decision which will affect your financial decision at large.
The usual practice is to pay dividends in cash. Other option is payment of the bonus shares or stock dividend. In this section we shall also discuss the stock split. The stock split is not a form of dividend; but its effects are similar to the effects of the bonus shares.
Most companies pay dividends in cash. Sometimes cash dividend may be supplemented by a bonus issue (stock dividend). Cash dividends are a distribution of the corporation’s net income. As such, dividends are not expenses and do not appear on the corporation’s income statement. A company should have enough cash in its bank account when cash dividends are declared. If the company does not have enough bank balance at the time of paying cash dividend, arrangement should be made to borrow funds. When the company follows a stable dividend policy, it should prepare cash budget for the coming period to indicate the necessary funds, which would be needed to meet the regular dividend payments of the company.
Before dividends can be distributed, the corporation’s board of directors must declare a dividend. The date the board declares the dividend is known as the declaration date and it is on this date that the liability for the dividend is created. Legally, corporations must have a credit balance in Retained Earnings in order to declare a dividend.
It is relatively difficult to make cash planning in anticipation of dividend needs when an unstable polity is followed. The cash account and the reserves account of a company will be reduced when the cash dividend is paid. Thus, both the total assets and the net worth of the company are reduced when the cash dividend is distributed. The market price of the share drops in most cases by the amount of the cash dividend distributed.
