The Definition Of A Dividend

The definition of a dividend as it relates to finance is:

a. a pro-rata share in an amount to be distributed

b. a sum of money paid to shareholders of a corporation out of earnings

These seem reasonably straightforward, but as with anything in life, there is much that lurks beow the surface...

An investor holding common stock / ordinary shares in a company will receive a return in one of two ways, either through capital gains or losses which come from price changes and dividends. There are practical limitations to a company paying out a dividend. Firstly, the payment must be legal. Company law will lay down the rules and guidelines. A firm must have distributable reserves on the balance sheet to be able to pay a dividend. A company may therefore dip into the undistributed profits of previous years.

Many firms will want to do this to ensure a dividend payment and maintain a certain level. Failure to do this can send out a negative signal about the firm.

A firm also must have the cash availaible to pay out. Any experienced investor will know that profits do not necessarily mean cash!