This brief report explores traditional and homemade dividends. It particularly considers the individual transactions that are associated with each phase of their creation, distribution, and remuneration.
Dividends are distributions that a stock corporation makes to its stockholders (“Definition,” 2019). When a dividend is declared, the cash portion of the forthcoming distributions is collectively recorded as a current liability. More specifically, a credit is posted to the dividends payable account and an equal debit is recorded to the retained earnings account. The result of this conjoint transaction is to move money from into short-term liabilities and away from equity. The dividends remain a liability on the books until they are actually paid. At the time when they are paid, the firm debits the dividends payable account and concomitantly credits the cash account. This cash drawdown serves to eliminate the outstanding liability (“Dividends,” 2019).
Dividends are almost always classified as a short-term liability. The reason for this classification is that the board of directors of the stock corporation commonly intends to pay out the dividends to its shareholders within one year. This means that dividends payable must be figured into such short-term liquidity calculations as current ratio and quick ratio (“The Difference,” 2019).
It is also the case that dividends payable represent an odd class of liability, since they represent an obligation of the firm to pay its own shareholders. By way of contrast, most types of liabilities are concerned with the compensation of third parties, including suppliers and lenders. In either case, since the dividend payment represents a departure of cash from the firm and, moreover, constitutes a legal obligation, it is considered a valid liability in all senses.
When a company announces a dividend, it is broadly construed as a sign of strong profitability, since the implication is that the firm can afford to distribute significantly of its profit to its shareholders. So, even though it momentarily affects the firm’s liquidity ratios, it in no way can be construed as a long-term handicap to the firm’s financial posture. However, a large dividend can have a sufficiently deleterious effect on the current ratio that the firm ends up breaching one or more loan covenants.
The fact that the firm can afford generously to distribute from its profits and the attendant implication of strong profitability generally results in a rallying of the stock price. By way of contrast, when a firm that has traditionally paid dividends decides no longer to do so, this may be interpreted as a perceived need on the part of the board of directors conservatively to consolidate their cash position. This would likely result to a decrease in the issue price (Grant, 2019).
A homemade dividend is quite different in nature from a traditional dividend. Specifically, homemade dividends constitute investment income that derives from selling a portion of one’s own portfolio. Homemade dividends also differ from others because dividends typically are paid according to a recurrent schedule, commonly either monthly or quarterly. By way of contrast, a homemade dividend is a special one-time sale (Chen, 2018). Firms may realize homemade dividends by selling from their own portfolios, commonly in preparation for financially restructuring, such as by spinning off a subsidiary firm (“Spinoff,” 2019).
It might be assumed that paying a homemade dividend would again cause the stock to rally, since it is strongly indicative of exceptional profits. However, a homemade dividend also depletes the firm’s position in its own stock, making it more vulnerable to hostile takeover. This could end up working against the appreciation of the stock price that would otherwise be expected.
Free essay samples and research paper examples available online are plagiarized. They cannot be used as your own paper, even a part of it. You can order a high-quality custom essay on your topic from expert writers:
EffectivePapers.com is a professional essay writing service committed to writing non-plagiarized custom essays, research papers, dissertations, and other assignments of top quality. All academic papers are written from scratch by highly qualified essay writers. Just proceed with your order, and we will find the best academic writer for you!
Chen, J. (2018, July 8). Homemade dividends. Investopedia. Retrieved from https://www.investopedia.com/terms/h/homemadedividends.asp.
Definition and explanation of dividends payable liability. (2019). Accounting Tools. Retrieved from https://www.accountingformanagement.org/dividends-payable/.
Dividends payable. (2019, March 30). Accounting tools. Retrieved from https://www.accountingtools.com/articles/what-are-dividends-payable.html.
Grant, M. (2019, June 30). How dividends affect stock prices. Investopedia. Retrieved from https://www.investopedia.com/articles/investing/091015/how-dividends-affect-stock-prices.asp.
Spinoff – Creating value by separating corporate assets. (2019). CFI Education. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/finance/spin-off-and-split-off/.
The difference between current ratio and quick ratio. (2019, August 14). Accounting Tools. Retrieved from https://www.accountingtools.com/articles/the-difference-between-current-ratio-and-quick-ratio.html.