Building successful businesses come with the challenge of deciding what to do with the profits. As a company, you have two primary choices – reinvesting the earnings back into the business or distributing profits to shareholders in the form of dividends. However, the decision is not limited to just these two options; there are other capital allocation choices like share repurchases or acquisitions.
- Dividends as a Percentage: Profitable companies often choose to divide their profits, allocating a percentage towards dividends and another towards reinvestment in the business. Despite this, issuing dividends is not always a necessity, except in cases of preferred shareholders.
- Accounting for Dividends: Whether you decide to issue dividends regularly or only after a strong financial period, accounting for this transaction is crucial. It’s essential to understand the accounting treatment of dividends, regardless of your business’s financial strength.
- Dividend Champions: To be considered a Dividend Champion, a stock must have paid rising dividends for 25 or more consecutive years, highlighting the company’s steady growth and commitment to rewarding shareholders.
Declaring a Dividend:
The process of issuing dividends starts with the Board of Directors officially authorizing the payment. Following Generally Accepted Accounting Procedures (GAAP), the declaration date is crucial to recording the dividend liability accurately. This involves debiting the retained earnings account, reflecting the company’s undistributed profits. Additionally, the dividends payable account records the amount owed to shareholders.
Date of Record and Payment:
The date of record determines the eligible shareholders, while the date of payment marks the actual transfer of funds to shareholders. These steps require precise bookkeeping to ensure accurate financial statements and balance sheet adjustments.
Impacting Financial Statements:
Dividends affect the balance sheet by increasing liabilities and decreasing retained earnings before reducing both cash and liability post-payment. Depending on your reporting method (GAAP or Cash Basis), the accounting treatment may vary, but the principles remain the same.
Conclusion:
Deciding on when, how much, and how often to pay dividends can signal the maturity and optimism of your business. However, accurate accounting for dividends is imperative to maintain financial integrity and ensure precise reporting. By following proper dividend reporting procedures, whether through GAAP or cash-basis accounting, you can guarantee your financial records reflect your business’s financial stability and commitment to rewarding shareholders.
