Interim dividends are surprise payments given to shareholders in between the usual quarterly or yearly dividends. It is like an unexpected bonus that pops up out of nowhere. Interim dividends add variety to how companies reward shareholders and give investors a boost at unexpected times. This article will explore what are interim dividends and proposed dividends and the treatment of proposed dividend and interim dividend in cash flow statement.
Table of Contents
What is Interim Dividend?
Interim dividends allow companies to share a glimpse of their profits with shareholders before the financial statements are finalized. It is a way for companies to indicate their financial well-being and reward their shareholders. The board of directors typically decides on the amount of interim dividends based on the financial performance and cash flow of the company.
The calculation of interim dividends varies. It can be a fixed amount per share or a percentage (%) of the value of shares like a percentage of the face value or market price.
Treatment of Interim Dividend in Cash Flow Statement
Interim dividends are recorded as expenses in the financing activities section of cash flow statement. These dividends involve actual cash payments made to shareholders throughout the year, usually before the final financial statements are complete. As interim dividends represent a distribution of company earnings to shareholders, they are categorized under financing activities. The cash flow statement records the announced interim dividend as a paid amount, rather than just an estimated amount.
Interim dividends affect cash flow as follows:
- Non-Operating Expense: Dividends are not considered expenses related to producing the goods or services (operations). Hence, they are not included in the operating activities section of the cash flow statement.
- Financing Shareholders: Dividends are categorized as a financing activity. They represent a way for the company to use shareholder equity to fund operations and reward shareholders for their investments in the company.
Example
To explain this concept, let’s take an example. Suppose a company decides to pay ₹15 crore as an interim dividend within a financial year. In cash flow statement of the company, this will show up under “Financing Activities” like this:
- Financing Activities: – Interim Dividend ₹15 crore (This negative sign means there is a cash outflow)
- Overall Impact: Paying the interim dividend makes the company have ₹15 crores less in its bank account. This reduction in cash is properly shown in the cash flow statement, which shows how the interim dividend payment affects the finance of company.
What is Proposed Dividend?
When a proposed dividend is declared for the upcoming financial year, it shows the amount of money that the board of directors of the company intends to distribute to its shareholders annually. However this proposal requires shareholder approval, usually voted on at the annual meeting at the end of the fiscal year.
The process of calculating proposed dividends involves these steps:
- Check Net Earnings: Evaluate the financial report of the company to determine its net earnings for the year.
- Adjust for Reinvestment: Deduct any part of the net earnings that the company plans to keep as retained earnings for future investments or operational requirements.
- Set Dividing Payout Ratio: Choose a percentage of the remaining earnings that the company wants to distribute as dividends. This percentage is the dividend payout ratio.
- Calculate Dividend Amount: Multiply the net earnings after subtracting retained earnings by the dividend payout ratio. This gives you the proposed dividend amount that the company intends to pay its shareholders.
To align with the financial health, investment goals, and shareholder concerns of the company, the Board of Directors proposes a dividend amount. Approval from shareholders is important to finalize the dividend and guarantee their participation in the decision making process.
Treatment of Proposed Dividend in Cash Flow Statement
Previous Year's Proposed Dividend:
- The previous year’s proposed dividend is added back to the net profit from operating activities in the cash flow statement. This adjustment is made because the proposed dividend is an appropriation of profit, not the actual cash outflow during the year. Adding it back helps to accurately calculate the actual cash generated from operating of the company.
- Subsequently, the proposed dividend amount is subtracted as a cash outflow in the financing activities in cash flow statement. This reflects the actual cash payment to shareholders which is categorized as a financing activity.
Current Year's Proposed Dividend:
- Basically, the current year’s proposed dividend is not included in the cash flow statement.
- This is not included because the current year’s proposed dividend is considered a contingent liability until it is approved by shareholders at the annual general meeting (AGM).
- Until shareholder approval is obtained, the proposed dividend remains uncertain and is treated as a contingent liability rather than an actual cash outflow. Therefore, it is not reflected in the cash flow statement.
Example
To explain this concept, let’s take an example. Suppose the company’s Net Profit from Operating Activities of ₹100 crore and the previous year’s Proposed Dividend of ₹20 crore. In cash flow statement of the company, this will show up:
- Cash Flow from Operating Activities: ₹100 crore (profit) + ₹20 crore (dividend) = ₹120 crore
- Cash Flow from Financing Activities: ₹20 crore (dividend outflow)
- Overall Cash Flow: ₹120 crore (operating inflow) – ₹20 crore (financing outflow) = ₹100 crore net cash flow.
Accounting standards may differ slightly based on location. For precise accounting, it’s advisable to refer to the specific AS in use.
Read also: Procedure for Appointment of Designated Partner in LLP – Latest Guide 2024
Conclusion
Understanding the treatment of proposed and interim dividend in the cash flow statement is important for investors. Proposed dividends are added back to net profit from operating activities and then deducted as cash outflows in financing activities. Meanwhile, interim dividends are recorded directly as cash outflows in financing activities. This insight helps investors gauge a company’s financial health and dividend policies for informed decision making.
Frequently Asked Questions (FAQ)
In India, companies paying dividends to shareholders are required to pay a tax of 15% on the proposed dividend amount.
Final Dividend is declared at the end of the fiscal year. It requires approval from shareholders. It represents the company’s profits for the entire financial year. Whereas Interim dividend is declared during the fiscal year before the financials are finalised.