All businesses want to make money, and the more, the better. Sometimes public companies like to offer their investors a share in the money they make, and that's where dividends come in.
Why companies pay dividends
A dividend is a portion of a company's profits that's distributed to investors. When companies make money, they have the option to reinvest that money in the business or share their proceeds with their investors. When a company declares dividends, it gives investors a certain dollar amount for every share of its stock.
Companies pay dividends not just to reward their investors, but to make their stock seem more attractive. For many investors, dividends are a sign of financial growth and strength. If a company is able to pay dividends, it means it has the money to do so. When investors see that dividends are being paid, they're more likely to be drawn to the stock, which could lead to more demand and cause the stock price to climb.
Net income is a measure of a company's earnings, or profit. It is calculated by taking a company's revenue and subtracting all costs associated with doing business. Net income is recorded on a company's income statement and is an important figure for investors because it indicates not just how well a company is doing, but how much money it might have left over to pay dividends.
Dividends and net income
Dividends represent a portion of a company's net income. However, dividends don't cause net income to go down. Rather, dividends are just one example of what a company might choose to do with its net income.
Let's say you run your own business and are left with $20,000 after paying for all the costs associated with earning that money. You might choose to stick that $20,000 in your bank account, or you might choose to put $18,000 in savings and write your friend a $2,000 check as a thank you for his support. But just because you write your friend that check doesn't mean you didn't make that $2,000; you're just choosing to give it away.
Dividends work the same way. When a company declares dividends, it doesn't change the fact that the company made that money. It is simply describing what the company did with the money it earned. The one exception is dividends from preferred stock, which are deducted from net income. The reason is that preferred stock dividends are required payments, whereas common stock dividends are not. Therefore, a company does not have to subtract what it pays in common stock dividends from its net income.
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