Investors contribute to the capital of a company with the primary intention of participating in its future growth and profits. Companies, on the other hand, seek out investors with the intention of raising funds for their operations. The investors who contribute to the capital of a company are termed as shareholders. They invest money in the company in exchange for an ownership share in proportion to their capital contribution. Shareholders can reap several benefits from their investment in profitable companies. They rely on certain profitability indicators while evaluating and finding successful and financially strong companies to invest their funds.
Definitions and meanings
Dividend is the share of profit of a company that is distributed to its shareholders. When a company earns profits, it may opt to distribute all or part of these profits to its shareholders.
Shareholders own part of the company in proportion to their shareholding vis-à-vis the total share capital of the company. As part owners they are entitled to receive share of company’s profits which they may receive as dividend. Board of directors typically makes a dividend announcement many days before the actual distribution of dividends to shareholders.
The dividend payment history of a company usually have a significant impact on its popularity as well as the market price of its shares. Companies that remain consistent in the payment of dividends often become popular among buy & hold type investors and see their shares being traded in the secondary market at higher prices.
Dividend is typically expressed as a percentage of the face value of company’s share capital. The formula for calculating total dividend payable is:
Percentage of dividend announced × Paid-up face value of each share × No. of paid-up shares outstanding
M/s ABC has earned profits of USD 5,00,000 in the year 2020. It has announced a dividend of 30% to its shareholders. Its shareholding pattern is as follows:
|Sr. No||Type of shareholder||Face value per share (USD)||Paid up value per share (USD)||No. of shares||Total paid up value (USD)|
|1.||Fully paid-up equity shares||10||10||1,00,000||10,00,000|
|2||Partly paid-up equity shares||10||6||50,000||3,00,000|
The total dividend payable to each class of shareholder will be:
Dividend = 30% × $13,00,000 = $3,90,000
Out of this total dividend announced, fully paid-up shareholders will receive $3,00,000 and partly paid-up shareholders will receive $90,000.
The following accounting entries would be passed by M/s ABC in its books:
(i). At the time of announcement:
Retained earnings a/c…..390,000 [Dr.]
Dividend payable a/c…..390,000 [Cr.]
(ii). At the time of payment:
Dividend payable a/c…..3,90,000 [Dr.]
Cash a/c…..3,90,000 [Cr.]
One shareholder of M/s ABC, Mr. X holds 1,000 fully paid-up shares and 200 partly paid-up shares. The dividend received by him in proportion to his shareholding would be:
($3,00,000 × 1,000/1,00,000) + ($90,000 × 200/50,000)
= $3,000 + $360 = $3,360
Dividend can be either interim or final. Dividend that is proposed by the board of directors and ratified by shareholders in the annual general meeting is final dividend. On the other hand, company can also declare interim dividend in anticipation of profits. This is declared by the board at any time before the end of the fiscal year.
Earnings per share:
The earnings per share (EPS) is the net profit of the company earned per outstanding equity share issued by the company for a specific fiscal period. EPS is indicative of the ability of the company to generate profits for its shareholders. Potential investors use it as a basis for gauging the performance of the company before deciding to invest.
Basis EPS = (Net profit – Dividend to preference shareholders*)/Weighted average number of outstanding shares
*Dividend to preference shareholders is deducted so as to reflect the net profit available for distribution to the equity shareholders
Diluted EPS considers the dilutive effect of all convertible securities issued by the company. Its formula is:
Diluted EPS = Net profit after adjusting for dilutive effects/(Weighted average number of outstanding shares + weighted average number of shares as a result of conversion)
Go to “basic earnings per share vs diluted earnings per share” article to know more about these two types of EPS
Difference between dividend and EPS:
The eight points of difference between dividend and EPS are listed below:
- Dividend is the distribution by a company to its shareholders, of part or all of its profits.
- EPS is the net profit earned by the company, per outstanding equity share.
2. Impact on shareholders income
- Dividend increases the income of the shareholders as it actually distributed by the company to the shareholder.
- EPS, on the other hand, does not necessarily have an immediate impact on the shareholder’s income as it only reflects the per share available profit but not actually received.
- Dividend as an absolute amount or in percentage form can only be a positive number as it is announced only when a company has profits available for distribution (current or accumulated).
- EPS can be positive or negative. EPS will be positive in case of current year profits and negative in case of current year losses.
4. Impact of past profits
- Dividend can be declared either out of current profits or accumulated profits of the company.
- EPS is only reflective of the current year profitability of the company.
5. Accounting entry
- Dividend is accounted for by debiting retained earnings (or profit and loss appropriation) account and crediting dividend payable. Subsequently, dividend payable is debited and cash account is credited at the time of payment to shareholders.
- EPS is theoretical calculation made for disclosure purposes in the financial statements. No accounting entry is passed for it.
6. Impact on cash flow of the company
- Dividend results in a payout by the company to its shareholders. It, thus, has an impact on the cash flow of the company.
- EPS is a theoretical calculation and does not have any immediate impact on the cash flow of the company.
7. Reporting in financial statements
- Dividend declared is reported as a deduction from retained earnings in the balance sheet. Dividend paid is reported in the financing activities section of the cash flow statement.
- EPS is reported at the end of the income statement of the company, after reporting of net profitability.
- Dividend can be of different types such as equity dividend, preference dividend or interim dividend and final dividend.
- EPS is primarily of two types – basic EPS and diluted EPS.
Conclusion – dividend vs EPS:
Both these parameters indicate profitability of the company. Dividend further indicates financial strength as well as liquidity position of the company. While EPS is used in several financial analysis ratios such as price earnings (PE) ratio. It can also help gauge the valuation of share price when compared with the market price. The gap between both these amounts is generally owing to company’s decision on use of its profits. Whether they opt to reinvest the profits back in the business or reward its shareholders by declaring a dividend.