Businesses, from large to small, pay out dividends to return cash to their company shareholders. As such, it’s important for limited company owners to have a solid understanding of how they work and what they mean for your bottom line, as well as your company’s cash flow. So, how do dividends affect cash flow? Are dividends included in the cash flow statement? Find out everything you need to know about these payments with our handy guide to dividends and cash flow.
What is a dividend?
First off, let’s make sure we’re up to speed on the terms – what is a dividend? Essentially, a dividend is a sum of money that a publicly-listed company pays out to a person who owns shares in the company (shareholders). In other words, dividends are how companies distribute their profit – the money left after business expenses, liabilities, and outstanding taxes (such as VAT or Corporation Tax).
What is cash flow?
Second point – what’s cash flow? This is fairly simple. Cash flow is the rate at which money passes through, in, and out of your company. It’s all about the actual flow of money. Cash flow is important to understand because it can provide you with an excellent overview of your company’s financial health.
How do dividends work?
Put simply, dividend payments need to be approved by the company director(s) before they can be paid out. Companies only pay dividends when there’s enough profit to cover the payout. If there isn’t, the dividend payment may be illegal, and your business can be subject to HMRC penalties.
A company’s policy regarding the frequency with which dividends are paid out, as well as the amount that they pay out, is referred to as a dividend policy. There’s no law regarding how frequently dividends can be paid out, but most companies choose to issue dividends quarterly or once every six months.
Are dividends included in the cash flow statement?
Cash flow statements allow you to review all the cash flows across your business, helping you to understand exactly what’s going on with your finances. So, are dividends in the cash flow statement? Yes, they are. It’s listed in the “cash flow from financing activities” section. This part of the cash flow statement shows all your business’s financing activities, including transactions that involve equity, debt, and dividends.
How do dividends impact cash flow?
Because dividends are considered a liability, rather than an asset, they won’t influence your business’s cash flow until the dividends are issued. Here’s how the process works in a little more detail:
Dividends are announced by the directors of the company.
On the balance sheet, your retained earnings are debited and dividends payable are credited. This means that an amount from your equity section is moved to the liabilities section.
When it’s time to pay out the dividends, dividends payable are debited, removing the liability from the balance sheet, and cash is credited (because dividends are a cash outflow).
Final word
As you can see, dividends are paid from the company’s cash flow, which means that your business needs to keep a close eye on any potential problems that may arise as a result of paying out dividends. This can ensure that you don’t accidentally run into trouble by paying out dividends at a moment when your business’s cash flow is in a potentially precarious position. Look at your free cash flow before dividends to work out whether it’s a good idea to pay dividends at a particular time.
For example, if you have a regular, healthy cash flow, it may be a good idea to have a regular dividend policy in which dividends are paid out quarterly. However, if your business’s cash flow is irregular or your business lacks liquidity, then an irregular dividend policy could be your best bet. Ultimately, you should work out what type of policy is best suited to your business’s financial position before making a decision.
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Reporting Requirements for Annual Financial Reports of State Agencies and Universities
General Accounting
Use the following four categories of activities to classify cash transactions:
- Operating
- Noncapital financing
- Capital and related financing
- Investing
Generally, cash receipts and cash payments are reported as gross rather than net. Two exceptions to the gross reporting are:
- Cash purchases and sales of cash and cash equivalents
- Assets and liabilities for which the turnover is quick and the maturities are three months or less (such as debt, loans receivable and the purchase and sale of highly liquid investments)
- Cash Flows from Operating Activities
Cash flows from operating activities result from providing services and producing and delivering goods. They include all other transactions not defined as noncapital financing, capital and related financing or investing activities. The operating activities section is, in a sense, a “catch-all” category.
Cash inflows (proceeds) from operating activities include:
- Cash receipts from sales of goods and services including receipts from collection of accounts receivable and both short/long-term notes receivable from customers and students arising from those sales
- Cash receipts from quasi-external operating transactions with other funds
- Grant receipts for activities considered as operating activities of the grantor government
- Cash receipts for reimbursement of operating transactions
- Cash receipts from collection of program loans
Note: “Program loans” are loan programs undertaken to fulfill a governmental responsibility (such as low-income housing mortgages and student loans). As the loans made and collected (including the interest) are part of a governmental program, the loan activities are reported as operating activities, rather than investing activities.
- Cash contributions to a defined benefit pension plan administered through a trust that meets the criteria in GASB 68, paragraph 4, or to a defined benefit OPEB plan administered through a trust that meets the criteria in GASB 75, paragraph 4.
- Other cash receipts not classified in the other categories.
Cash outflows (payments) from operating activities include:
- Cash payments to suppliers of goods and services
- Cash payments to employees for services including benefits
Note: Separate accounts payable and payroll payable when determining the cash payments.
- Cash payments for grants considered to be operating activities of the grantor
- Cash payments for quasi-external operating transactions (including payments in lieu of taxes)
- Cash payments for program loans
- Cash payments for pensions or OPEB regardless of whether the defined benefit pension plan or defined benefit OPEB plan is administered through a trust that meets the specified criteria of either GASB 68, paragraph 4, or GASB 75, paragraph 4, respectively.
- Other cash payments not classified in the other categories
- Cash Flows from Noncapital Financing Activities
Cash flows from noncapital financing activities include borrowing money and repaying the principal and interest on amounts borrowed for purposes other than to acquire, construct or improve capital assets.
Cash inflows (proceeds) from noncapital financing activities include:
- Cash receipts from short and long-term borrowings used for purposes other than to acquire, construct or improve capital assets
- Cash receipts from grants and voluntary non-exchange transactions (gifts) not used for capital assets or for specific activities considered to be operating activities of the grantor
- Cash receipts from other funds except amounts used for capital assets, quasi-external operating transactions or reimbursement for operating transactions
- Cash receipts from property and other taxes not specifically restricted for capital purposes
- Cash receipts from proceeds of state appropriations
Cash outflows (payments) for non-capital financing activities include:
- Repayments of principal and interest on borrowings for purposes other than acquiring, constructing or improving capital assets
- Grant payments to other governments or organizations for activities not considered as operating activities of the grantor
Note: It is irrelevant whether the grantee uses the grant as an operating subsidy or for capital purposes.
- Cash payments to other funds except for quasi-external operating transactions
- Cash Flows from Capital and Related Financing Activities
Cash flows from capital and related financing activities include acquiring and disposing of capital assets, borrowing money to acquire, construct or improve capital assets, repaying the principal and interest amounts and paying for capital assets obtained from vendors on credit.
Cash inflows (proceeds) from capital financing activities include:
- Receipts from proceeds of issuing or refunding bonds and other short or long-term borrowings used to acquire, construct or improve capital assets
- Receipts from capital grants awarded to the governmental enterprise or other contributions for capital assets
- Receipts from contributions made by other governments, organizations or individuals (gifts) for the specific purpose of defraying the cost of acquiring, constructing or improving capital assets
- Receipts from sales of capital assets and proceeds from insurance on capital assets that are stolen or destroyed
- Receipts from special assessments or property and other taxes levied for capital purposes
Cash outflows (payments) for capital financing activities include:
- Payments to acquire, construct or improve capital assets
- Payments on principal and interest or refunding on amounts borrowed for capital assets
Note: Proceeds of a refunding debt issue used to refund capital debt are reported in the capital and related financing category. Likewise, subsequent principal and interest payments on the refunding debt are also reported as cash outflows in the capital and related financing category.
- Cash Flows from Investing Activities
Cash flows from investing activities include making and collecting loans (except program loans; see Cash Flows from Operating Activities) and the acquisition and disposition of debt or equity instruments.
Cash inflows (proceeds) from investing activities include:
- Receipts from collections of loans (except program loans) and sales of other entities’ debt instruments (other than cash equivalents)
- Receipts from sales of equity instruments and from returns of investment in those instruments
- Receipts of interest and dividends received as returns on loans (except program loans), debt instruments of other entities, equity securities and cash management or investment pools
- Receipts from withdrawals on investment pools the governmental enterprise is not using as demand accounts
Cash outflows (payments) for investing activities include:
- Payments for loan disbursements (except program loans) and acquisition of debt instruments of other entities
- Payments to acquire equity instruments
- Payments for deposits into investment pools the governmental enterprise is not using as demand accounts