Dividends are issued as cash, stocks, or related forms. The Board of Directors (BoD) of a company decides on the dividend to be paid and requires shareholders' approval. Looking at its performance, a company's BoD may or may not propose a dividend. The company makes a provision for the dividend payable. It means it has made short-term fund arrangements to manage the actual dividend payment post-approval.
This article explores key information about the proposed dividend to help you understand its relevance for a company and its shareholders.
What Is Proposed Dividend?
A proposed dividend is the dividend proposed to be paid to the shareholders during a financial year. It forms an integral source of temporary working capital financing.
A company's BoD proposes the dividend at the end of a financial year. They propose the dividend before the financial statements for that year get approved. In other words, a dividend recommended by the BOD but requiring approval by shareholders is called a proposed dividend. The BOD suggests the dividend post-preparation of the annual accounts. So, the proposed dividend is paid to the shareholders in the next financial year.
Key Features of Proposed Dividend
- There is no cost of financing involved via the proposed dividend
- There are no legal formalities involved with the proposed dividend recommended
- A proposed dividend does not entail floatation cost - a cost a company incurs when it issues new shares or stock.
How Does Proposed Dividend Work?
The BODs are the only authority to approve and authenticate a company's financial statements. Based on a company's performance in the current year, the BODs may think of proposing a dividend. The proposed dividend is just a suggestion; the shareholders have no obligation to accept it. Shareholder approval is required to make the proposed dividend payable. Till such time, the proposed dividend is not the company's liability. Shareholders have the right to decrease the proposed dividend amount but cannot declare a higher amount.
The proposed dividend becomes the company's liability only when shareholders declare it at the Annual General Meeting (AGM) and has to be paid within 30 days from the declaration of the dividend.
Till the shareholders declare the dividend or accept the recommendation, the BODs have the right to modify or withdraw the proposed dividend. Likewise, shareholders can reject the overall BOD's recommendation or modify it. So, the company's liability arises only when the said recommendation or modification has resulted in the declaration of dividends by the shareholders.
Also, the amount earmarked as a temporary source of finance for paying the proposed dividend based on the BOD's recommendation cannot be utilised for an existing liability. The same has to be used only for its intended purpose, which is, paying the dividend post-shareholder declaration.
Impact of Proposed Dividend on Stock Price
When the BOD proposes dividends, there is no impact on the company's share price as it is just a recommendation that needs the shareholder's approval at the Annual General Meeting.
Treatment of Proposed Dividend in Financial Statements
As per the amendment in Schedule 3 of the Companies Act 2013, the proposed dividend should only appear as a footnote under Notes to Accounts in the Balance Sheet.
Treatment in Profit & Loss Account
The proposed dividend does not impact a company's Profit and Loss Statement. However, its impact is considered in the fiscal year when the shareholders accept and declare it at the AGM.
Treatment in the Balance Sheet
The BOD's proposed dividend does not become a liability for the company till the shareholders accept and approve it in the forthcoming AGM. According to Accounting Standard 4 – Para 14, if a company recommends dividends to shareholders post the Balance Sheet date, the company need not recognise the proposed dividend as a liability in its Balance Sheet unless stated otherwise by law. The proposed dividend cannot be considered a Current Liability or a Provision in the current Balance Sheet. It has to be shown only in Notes to Accounts.
Treatment in the Cash Follow Statement
The proposed dividend for the last fiscal year will be considered as a cash outflow in the current fiscal year based on the assumption that shareholders will approve the proposed dividend in the coming Annual General Meeting. In the current year's Cash Flow Statement, the proposed dividend needs to be given any effect. As it is not provided for, it becomes a contingent liability until the shareholders declare the proposed dividend in the Annual General Meeting.
Declaration in Directors' Report
According to Section 134 sub-section 3 clauses (k) provision, the BODs have to state in the Directors' Report the amount of proposed dividend, if any, that they have recommended would be paid as dividends. So, the proposed dividend forms part of the Directors' Report.
Benefits of Proposed Dividend
Key benefits for company include:
Cheap source of finance for a company
A proposed dividend is an important temporary source of short-term finance for a company, i.e., temporary working capital similar to taxation provision. By providing for the dividend payable, the company gets to arrange funds for the time period between the proposed dividend and when the dividend gets approved and its actual disbursal to the shareholders.
No obligation for company to pay interest
The company is not obligated to pay interest to the shareholders when the BOD proposes a dividend. A proposed dividend is the initial phase when the BOD discuss, brings forth, and suggests to the shareholders their intention to declare a dividend. The proposed dividend suggestion could go through various amendments. Shareholders need to cast their votes to approve or reject the proposed dividend. So, there is no obligation for the company to pay interest to shareholders for a proposed dividend.
Maintains shareholder trust for a company
By declaring dividends, companies retain the trust of their shareholders, who will continue to invest in the company.
Key Benefits for Shareholders include:
Increase Shareholder Income
The proposed dividend, when declared, increases income for the shareholders. Dividend helps shareholders generate revenue from their investments in the company apart from wealth generation over time.
Disadvantages of Proposed Dividend
Key drawbacks are:
Temporary Source of Finance for a company
A proposed dividend provides funds only for a short period. In other words, it provides funds for only the interim period between when the BOD's proposed dividend and when it gets distributed to the company's shareholders. As such, the company can utilise the fund for only a very short time.
Small Value Funding
Another disadvantage of a proposed dividend is that the funding available from this source is very small compared to other company funding sources.
A proposed dividend is a recommendation by the BOD to pay dividends to its shareholders. It implies a year-end dividend and is just a proposal without involving any payment. Based on the company's performance and potential plans involving cash, working capital, and profits that need to be retained or distributed, the BOD proposes a dividend for that year. The proposed dividend has to be approved by the shareholders in the AGM. Only then it becomes a liability for the company. The declared dividend has to be paid within 30 days from the date of such declaration. A proposed dividend helps the company maintain its short-term funding proposition across dividends that would need to be paid if shareholders approve the proposal in the ensuing AGM. A proposed dividend is a company's way of appreciating its shareholders' faith and support in its activities.
How does the dividend differ from a proposed dividend?
Dividend payable gets declared before the preparation of the financial statements. On the other hand, the proposed dividend gets announced post-preparation of the financial statements.
Where does the proposed dividend appear on the Balance Sheet?
The proposed dividend does not appear either as Current Liabilities or as Short-term Provisions on the liability side of the current Balance sheet. It should appear in Notes to Accounts.
How many times can a company declare a dividend?
A dividend can be declared more than once in a year by a company out of its current year profits after providing for depreciation.
Is proposed dividend taxable?
The proposed dividend becomes taxable as and when it is proposed.
Can a proposed dividend be considered an expense?
Proposed Dividends are shown as current liability in the balance sheet. Also, Dividends are distributed out of a company's accumulated earnings. As such, they are not an expense. So, a proposed dividend does not appear as an expense in a company's Profit and Loss Statement.
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