A cash dividend is a pro rate distribution of cash to stockholders. For a corporation to pay a cash dividend, it must have:
→ Retained earnings: The legality of a cash dividend depends on the laws of the state in which the company is incorporated. Payment of cash dividends from retained earnings is legal in all states. In general, cash dividend distributions from only the balance in common stock (legal capital) are illegal.
→ Liquidating dividend: A dividend declared out of paid-in capital is termed a liquidating dividend. Such a dividend reduces or “liquidates” the amount originally paid in by stockholders. Statues vary considerable with respect to cash dividends based on paid-in capital in excess of par or stated value. Many states permit such dividends.
→ Adequate cash: The legality of a dividend and the ability to pay a dividend are two different things. For example, Nike, with retained earnings of over $3 billion, could legally declare a dividend of at least $3 billion. But Nike’s cash balance is only $193 million.
Before declaring a cash dividend, a company’s board of directors must carefully consider both current and future demands on the company’s cash resources.
→ A declaration of cash dividends: A company does not pay dividends unless its board of directors decides to do so, at which point the board “declares” the dividend. The board of directors has full authority to determine the amount of income to distribute in the form of a dividend and the amount to retain in the business. Dividends do not accrue like interest on a note payable, and they are not a liability until declared.
The amount and timing of a dividend are important issues. The payment of a large cash dividend could lead to liquidity problems for a company. On the other hand, a small dividend or a missed dividend may cause unhappiness among stockholders. Many stockholders expect to receive a reasonable cash payment fr4om the company on a periodic basis.
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