What is a distribution of earnings to the stockholders of a corporation called?

Corporate stockholders are entitled to share in the company's profits. Small businesses that are set up as corporations typically have stockholders who wear multiple hats as owners, directors and employees. Stockholders in this type of small corporation set compensation levels for stockholders who work for the company and have control over how profits are paid out.

Table of Contents Show

• Retained Earnings
• Financial Decisions
• Dividend Payments
• Stockholders and Equity
• Distributions of Cash
• Dividend Declaration
• Asset Distributions
• Business Failure

Net Income

1. A corporation is a taxpayer under the Internal Revenue Code and must file an annual federal income tax return and pay taxes before the corporation can determine how much money it has left over as profit. The IRS allows businesses to deduct reasonable and necessary business expenses from all of the money the corporation took in during the year to arrive at an amount, called net income, that is taxed at the corporate rate. Profit is the amount of net income that is left over after the corporation pays taxes.

Retained Earnings

1. After-tax net income, or profit, is segregated on the corporation's books in its retained earnings account. This account keeps track of money that the corporation has already paid taxes on. Profits are distributed to eligible stockholders out of this account.

Financial Decisions

1. Profits are placed in the corporation's retained earnings account, but the corporation is not required to distribute those profits to stockholders. The decision to distribute profits is made by the corporation's board of directors. The board can decide to keep profits in the corporation as working capital or to fund a new endeavor. In a small corporation where stockholders are also directors of the board, the owners vote whether or not to distribute profits. The corporation can distribute all or a portion of the profits in its retained earnings account.

Dividend Payments

1. Profit distributions to stockholders are called dividends. Dividends must be distributed in equal amounts per share. Most small corporations have one class of stock, called common stock, so all stockholders get the same dividend distribution at the same time. Another class of stock, called preferred stock, can be used by small corporations to give certain stockholders a preference in the distribution of profits. Dividend payments to preferred stockholders have priority over payments to common stockholders.

Timing

1. Dividends can be paid out by the corporation at any time at the discretion of the board. Small corporations, however, tend to pay out dividends once at the end of the year because the stockholders are often not interested in carrying large amounts of retained earnings in the corporation's account. Since the stockholders of small corporations are often also employees of the company, they take a salary from the corporation to meet ongoing needs and a profit distribution at year-end.

People and entities own or invest in corporations aiming to derive value from their ownership. These owners, or shareholders, often realize this value through the corporation's increase in value and the associated appreciation in the price of its shares. For most private corporations, however, shareholders realize this value through the profit distributions they receive. Profits are distributed in cash. When a corporation shuts down, it also may distribute its assets to shareholders.

Stockholders and Equity

1. Stockholders in corporations typically contribute cash although a stockholder may contribute business assets in lieu of cash. Initially, cash is used to capitalize the business and later contributions are used to fund growth. The number of shares a stockholder owns denotes the ownership interest. Stockholder contributions are reflected in stockholder's equity on the balance sheet. In addition to contributed capital, stockholder's equity also includes retained earnings, which are net profits or losses retained by the company.

Distributions of Cash

1. Distributions paid to shareholders reduce stockholder's equity and its component, retained earnings. Distributions of cash, or cash dividends, are typically called "dividends." These distributions are reflected on your corporation's balance sheet and in the financing section of the cash-flow statement. Companies typically reinvest earnings to maintain operations and fund growth. Rapidly expanding companies generally pay no dividends and instead use all of their earnings to fund expansion. Conversely, mature, stable companies often distribute a high percentage of earnings as dividends.

Dividend Declaration

1. Before a corporation can distribute dividends, its board must first declare the dividend. Laws require corporations to show a positive number in retained earnings that exceeds the amount of the dividend to be declared. In practical terms, a corporation also needs sufficient cash on its balance sheet to pay a dividend while still being able to meet any financing or operating obligations.

Asset Distributions

1. Companies use their assets to support operations. Corporations sell assets they no longer need to generate cash to purchase other assets, pay off debt or support operations. Therefore, healthy corporations rarely distribute non-cash assets to shareholders. Corporations generally only distribute assets when the company has partially or wholly failed and is in the midst of shutting down a portion or all of its business.

Business Failure

1. When a corporation fails, it distributes to shareholders only those assets that remain after it has paid all of its outstanding creditors. It is usually easier for a corporation to sell its assets and distribute the proceeds. However, if the corporation has few assets, finds it too time consuming to find buyers or has only one or two shareholders, it will parse out the assets according to the assets' value and the shareholder's ownership interest.

A dividend, also called a stockholders’ dividend, is a payment made by a company to its owners and shareholders. Dividends compensate equity investors for their capital contribution. Generally, the dividend is a portion of current year net earnings, but sometimes special dividend payments are made, funded with retained earnings or asset sales.

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A dividend, or stockholders’ dividend, is a payment made by a company to its owners and stockholders. The dividend payment represents a portion of the company’s current net earnings, but special dividend payments, funded with retained earnings or asset sales, are sometimes made.

Well-established companies typically pay higher dividends than early-stage companies, as mature firms tend to have more stable, predictable earnings and fewer investment opportunities than growth-oriented companies. As a result, established firms often return more cash to their stockholders in the form of dividends.

Most companies pay dividends once per quarter, but the frequency can vary. Some companies pay a monthly dividend, while others pay an annual dividend. Others pay no regular dividend at all.

Ultimately, the amount and frequency of dividend payments is determined by the company’s board of directors.

The vast majority of dividend distributions are made in cash. However, a company may sometimes pay a stock dividend to its shareholders. Rather than a cash payout, a stock dividend involves the issuance of additional shares of stock.

The determination of a dividend is unique to the company who is paying it. Deciding on the amount of a dividend is a big strategic decision for a company, given the focus many investors put on the amount of income produced by their investments.

As a result, most companies plan, communicate and initiate their dividend distributions in line with a well-structured dividend policy. At a minimum, the policy outlines the amount of future dividend payments and their frequency.

The three primary types of dividend policies are outlined below.

A stable dividend policy is the most common and easiest to administer. The objective is to pay a steady and predictable dividend over time, regardless of earnings volatility.

Dividend increases or decreases are aligned with the long-term growth trajectory of the company, not quarter-to-quarter earnings fluctuations. Ultimately, this type of plan gives stockholders a high degree of confidence in the amount and timing of future dividends.

With a constant dividend policy, the company pays out a certain percentage of its earnings every period. If earnings are up, investors get a larger dividend; if earnings are down, investors get a smaller dividend — or perhaps no dividend at all.

The main drawback with this type of policy is the potentially volatile nature of the dividend, which can make it difficult for those investing to plan cash flow.

With a residual dividend policy, a company prioritizes the reinvestment of cash flow over dividend payouts, meaning that the company only pays dividends if it has earnings leftover after making investments in capital expenditures and working capital. At a high level, this process works as follows:

• An example company has net earnings of $100 million.
• The company’s investments in capital expenditures and working capital total $85 million.
• Subtracting capital expenditures and working capital investments from net earnings, this leaves $15 million available for dividend distributions ($100M - $85M = $15M).

A residual dividend policy has the potential to be more volatile than the other types of dividend policies. Nevertheless, many companies and stockholders favor this type of arrangement due to its focus on the creation of long-term economic value.

Let’s look at an example scenario from the stockholder’s perspective, as you may encounter a situation similar to this one while evaluating your own personal finance situation. Assume the following:

• You own 1,000 shares of Company XYZ stock, which is currently priced at $200 per share.
• Earnings per share (EPS) totaled $7 for the quarter.
• Company XYZ maintains a stable dividend policy with quarterly distributions.
• Long-term growth projections support a quarterly dividend payment of 40 percent of earnings.

Based on the information above, you as a stockholder can expect the following quarterly dividend payment:

Quarterly Dividend Payment = Number of Shares Owned × EPS × Dividend Payout Ratio
Quarterly Dividend Payment = 1,000 × $7 × .40 = $2,800

Annualized, this produces the dividend yield computed below.

Dividend Yield = (Quarterly Dividend Payment ÷ Number of Shares Owned × 4) ÷ Stock Price
Dividend Yield = ($2,800 ÷ 1,000 × 4) ÷ $200 = 5.6%

Dividends are just one aspect of a stock’s worth. The potential for stock price appreciation is often a much larger determinant of value. Smart investors are aware of this and base their investment decisions on the complete picture, not just the size of a dividend payment.

That said, dividends are very important to income-focused investors and especially important to retirees, who often rely on the income to live. For these investors, tracking the consistency of a company’s dividend over time is a smart way to assess the reliability of the income.

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