What is a Cash Dividend and How does it Work?

Capital appreciation is not the only way to generate returns from the stock market. In fact, you can generate passive income from the market by investing in stocks that pay regular cash dividends. These can be used to supplement your primary income source or reinvested to enhance your wealth creation potential. 

In this article, we are going to explore the meaning of a cash dividend, how it works with the help of an example, and the various advantages and drawbacks of issuing it to investors.     

What Is a Cash Dividend?

Since shareholders are ultimately the owners of the company, they are entitled to the profits earned by the company. A cash dividend, also referred to as a dividend, is the distribution of a part of the profits that a company generates to its shareholders in the form of cash. 

Now that you are aware of the meaning of a cash dividend, let us take a look at how it works.

A cash dividend is typically expressed on a per-share basis. For instance, a company may declare a dividend of ₹5 per share, meaning that shareholders would get ₹5 for every share they own. There are four dates that you, as an investor, must be aware of whenever your company declares a dividend. 

• Dividend Declaration Date: It is the date on which the dividend payments are declared publicly. 
• Record Date: This is the date by which you must be a shareholder of the company to be eligible to receive cash dividends.  
• Ex-Dividend Date: It is the date on which the stock price will be adjusted downward by the amount of the dividend declared.  
• Payment Date: This is the date on which the dividend payments are made to the eligible shareholders. The payment date is usually set a few days apart from the record date to give the company enough time to compile the list of eligible shareholders and transfer the funds to them. 

Now, it is important to remember that cash dividends are only declared if the company is profitable. Some companies may also choose to retain the profits instead of distributing them to their shareholders. The retained profits are then used to expand and grow the business. 

How Do You Calculate Cash Dividends?

If you are a shareholder of a company that just declared a cash dividend, you can calculate the total amount of dividend you are entitled to by using the following formula: 

Total Dividend Amount = Cash Dividend Per Share x Total Number of Shares Held 

Example of a Cash Dividend 

Here is a hypothetical example to help you better understand the concept of cash dividends. 

Assume a company called XYZ Limited has issued around 1 crore equity shares. During the financial year 2023-2024, XYZ Limited made a profit of ₹50 crore. It decided to distribute ₹25 crore to its shareholders and declared a dividend of ₹25 per equity share. 

The record date and ex-dividend date for this cash dividend distribution were notified as June 28, 2024. This means that only investors who appeared on the company’s books as shareholders by June 28, 2024, would be eligible to receive dividends. 

Say you purchased 100 shares of XYZ Limited on June 26, 2024. This means you would have become a shareholder of the company on the record date, making you eligible to receive the cash dividend. The total amount of dividend you are eligible for can be calculated using the above formula. 

Total Dividend Amount = (₹25 per equity share x 100 shares) = ₹2,500 

Now, suppose you purchased 100 shares of XYZ Limited on June 28, 2024, instead. This means that you would have become a shareholder of the company only on June 29, 2024, making you ineligible for the cash dividend.

How Does a Company Issue Cash Dividend?

As an investor, you must understand the process that a company follows when declaring dividends. Here is a quick overview of the step-by-step process.

• Step 1: Decision to declare dividends 

If a company posts a profit during a particular financial year, the board of directors of that company convenes a meeting to decide whether to distribute the profits as dividends or to retain them. 

• Step 2: Publishing the decision 

If the board determines that there are enough profits to distribute to shareholders and that they do not need the cash for the foreseeable future, the decision to distribute cash dividends is taken. The board of directors then publishes the decision along with key information such as the rate of dividend, dividend declaration date, record date, ex-dividend date, and dividend payment date.     

• Step 3: Determining eligible shareholders

Working with its Registrar and Transfer Agent (RTA), the company then prepares a list of shareholders eligible to receive the dividend. Only shareholders that appear on the company’s books as of the record date are considered.  

• Step 4: Transferring the cash dividends   

Once the list of eligible shareholders is prepared, the RTA is tasked with the responsibility of transferring the cash dividends to all eligible shareholders based on their holdings.  

What are the Benefits of Issuing Cash Dividends? 

Companies as well as investors benefit from the issue of cash dividends. Let us look at a few of the key advantages. 

• Passive Income Source 

Investors can create a steady source of income by investing in cash dividend stocks. However, it is important to note that not all companies issue dividends. 

• Shareholder Satisfaction 

By distributing cash dividends, companies can keep their shareholders satisfied and enhance loyalty. Additionally, it may also help them attract new investors who are focused on earning regular income.  

• Positive Perception 

Companies that regularly issue cash dividends are usually viewed in a positive light by investors and analysts. Such a positive perception could potentially drive their share prices higher.

• Flexibility 

Investors have the freedom to use cash dividends as they see fit. They can either use the cash to supplement their primary source of income or reinvest it to increase their wealth creation potential.  

The Difference Between Cash Dividend and Stock Dividend

As you have already seen, a cash dividend is the distribution of a portion of a company’s profits in cash. A stock dividend, meanwhile, is the distribution of additional shares to shareholders instead of cash. 

Cash dividends reduce the company’s cash reserves, whereas stock dividends do not have any such effect. However, stock dividends lead to an increase in the total number of outstanding shares and can lead to a dilution of earnings per share (EPS). 

Conclusion

With this, you must now be aware of the concept of cash dividends and their benefits for investors. Now, if you are planning on investing in cash dividend stocks, remember to thoroughly analyse the financial position of the issuing companies. This will help you determine the sustainability of dividend payments and their impact on the stock’s growth potential.  

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