How and why does a company pay Dividends?

Dividends are paid to the shareholders of the company only if a company makes profit and can generate future cash flows. It is a reward to the shareholders for excellent operation of the business. Cash flow is determined by subtracting the company's expenditure from the cash generated from the business after paying off all its liabilities. This cash flow can either be invested back into the business for growth and expansion or can be distributed as dividends to its shareholders.

In case of a low growth company there are more chances for payment of dividends and in case of a company which is aiming at further growth and expansion may declare less or no dividends. Companies often distribute this cash flow in two parts. One part can be reinvested in business and the other can be distributed as dividends.

Payment of dividend varies from company to company. They may be paid either on a quarterly basis or a monthly basis. In case a shareholder has an online trading account then the dividend is directly deposited into the account. If you do not own an online account then you physically receive a check from the company which you can in cash.

There are several reasons why companies pay a dividend to its shareholders.

  • Firstly payment of dividend reflects a sound picture of the business and provides certainty of the business. This may also attract investors and hence a company can raise capital easily in the future.
  • A company which has been paying dividends regularly for a long time has goodwill and if because of market slump is unable to pay dividends does not affect its soundness. Hence, it is always advisable to pay a low dividend rather than a no dividend. Everything has a flip side to it; similarly declaration of dividends also has some short comings.

Therefore, a company must maintain a balance between the two approaches which are residual reinvested in the company and stability of shareholders by declaring dividends any extra income makes shareholders glad and helps establishing a confidence level.

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