What is a dividend?
A dividend is a portion of a company’s profits and retained earnings that a company pays out to its shareholders.
Profit generated and retained earnings accumulated can be either reinvested in the company to fund, inter alia, acquisition of assets, development of projects or the earnings can be distributed to the shareholders. The decision is made by the board of directors.
Interim dividends and final dividends
The board of directors of a company may decide to issue an interim dividend during the financial year, typically on a quarterly or semi-annual basis. Usually, an interim dividend is distributed before the company’s financial statements for a financial year are released.
A final dividend is paid out after the final version of a company’s financial statements for a particular financial year.
Are dividends guaranteed?
Ordinary shareholders are not guaranteed dividend payments. It depends on decisions of the board of directors, profits generated, retained earnings available, and economic factors (locally and globally), to name a few prerequisites.
In addition, preference shareholders enjoy preference over all ordinary shareholders with regard to the distribution of dividends.
Preference shareholders are guaranteed fixed returns in the form of guaranteed preference share dividends if the company generates a profit. However, these payments are not always paid out when they are due and can be paid out at a later stage.
Regulations about dividends in the Companies Act of South Africa
Dividends are classified as distributions
The Companies Act, Act 71 of 2008, (hereafter referred to as the Act) includes a dividend in the first part of its definition of ‘distribution’, which reads as follows:
‘Distribution’ means a direct or indirect –
- Transfer by a company of money or other property of the company, other than its own shares, to or for the benefit of one or more holders of any of the shares of that company or of another company within the same group of companies, whether –
- in the form of a dividend’[i]
Distributions are subjected to the solvency and liquidity test
According to section 46 of the Act, a company is not allowed to make any proposed distribution unless:
- ‘the board of the company, by resolution, has authorised the distribution’ (section 46 (1) (a) (ii));
- ‘it reasonably appears that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution’ (section 46 (1) (b));
- ‘the board of the company, by resolution, has acknowledged that it has applied the solvency and liquidity test, as set out in section 4, and reasonably concluded that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution’ (section 46 (1) (c)).
The solvency and liquidity test
The Act describes the solvency and liquidity test as follows in section 4 (1):
‘For any purpose of this Act, a company satisfies the solvency and liquidity test at a particular time, if considering all reasonably foreseeable financial circumstances of the company at that time –
- The assets of the company or, if the company is a member of a group of companies, the aggregate assets of the company, as fairly valued, equal or exceed the liabilities of the company or, if the company is a member of a group of companies, the aggregate liabilities of the company, as fairly valued; and
- It appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months after the date on which the test is considered, or in the case of a distribution, 12 months following that distribution.’
Dates associated with dividends
The following dates are noteworthy concerning dividends distributed by companies.
- Announcement date
The announcement date, also known as the declaration date, is the date on which the board of directors of a company determines the amount and payment date of a dividend.
- Ex-dividend date
The ex-dividend date, also called the record date or simply the ex-date, is the day on which the list of shareholders who are eligible for dividends, is finalised by the company.
For instance, if the ex-date of a company’s shares is March 12, then the shareholders who buy the shares on or after 12 March will not qualify to get the dividend. Shareholders who own shares prior the ex-date will receive the dividend.
- Payment date
This is the day on which a company pays the declared dividends to its shareholders.
Tax on dividends for South African taxpayers
Dividends withholding tax (DWT), commonly known as dividends tax, has replaced secondary tax on companies (STC) since 1 April 2012. STC was a tax levied on companies on the declaration of dividends.
Regarding local dividend income, dividends tax is a withholding tax of 20% that is deducted from dividend payments to shareholders and paid over to SARS by the withholding agent, which is either the company paying the dividend or the regulated intermediary.
The company or the regulatory intermediary is required to pay the tax withheld to the South African Revenue Service (SARS) on or before the last day of the month following the month in which the dividend was paid.
With regard to foreign dividend income, a taxpayer is obliged to report the South African rand (ZAR) equivalent amount to SARS. Foreign dividends are usually taxable, although, you will be allowed to deduct any tax you pay in a foreign country where the dividends were received.
Accounting ratios concerning dividends
There are different ratios in which dividends are used to determine the financial performance of a company.
Dividend Payout Ratio (DPR)
The dividend payout ratio (DPR), also referred to as the payout ratio, calculates the amount of dividends paid to shareholders in relation to the net income of a company.
Put differently, the dividend payout ratio (DPR) indicates the percentage of net income that is distributed to shareholders in the form of dividends.
The amount of the net income that is not paid out as dividends is retained by the company to invest in key operations, pay off debt obligations, or to increase the retained earnings of the company.
There are several formulas to calculate the dividend payout ratio, the following formula being the most popular one.
- Formula for determining the dividend payout ratio of a company:
DPR = Total dividends/Net income
Where:
Net income (also called net earnings) = sales (revenue) minus cost of goods sold (COGS), other expenses (administrative, general, operating), depreciation, interest, and taxes.
- Example of the DPR
Company GVV reported a net income of R100 000 for the financial year. Interim dividends of R5 000 and final dividends of R7 500 were distributed to shareholders.
Dividend payout ratio = (R5 000 + R7 500)/R100 000
= R12 500/R100 000
= 13%
The DPR of 13% shows that company GVV is paying out 13% of its net income to shareholders, while the remaining 87% is kept by the company to, among other things, expand operations, pay off debt, or to increase the company’s retained earnings.
Dividend coverage ratio (DCR)
The dividend coverage ratio (DCR), also called dividend cover, measures the number of times that a company can pay dividends to its shareholders.
This metric enables investors to determine the level of risk associated with the receipt of dividends on their investment in a company. Put in other words, the DCR is an estimation of the risk to which investors are exposed of not receiving dividends.
- Formula to calculate a company’s dividend coverage ratio:
DCR = Net income/Dividends declared
Where:
- Net income = earnings after the deduction of all expenses (including depreciation) and taxes.
- Dividends declared exclude dividends paid to preference shareholders.
- Example of the dividend coverage ratio
The following figures were obtained from company WWW’s financial statements:
- Profit before tax: R500 000
- Corporate income tax rate: 28%
- Dividends paid to shareholders: R45 000 (Including R15 000 dividends paid to preference shareholders)
DCR = (R500 000 x 0.72)/(R45 000 – R15 000)
= R360 000/R30 000
= 12
The DCR of 12 indicates that company WWW will be able to pay dividends to its ordinary shareholders at least 12 times.
Dividend yield
The dividend yield is a financial ratio that indicates how much a company pays out in dividends each financial year relative to the market value of its shares. Dividend yield is expressed as a percentage.
Put differently, the dividend yield ratio determines the percentage of a company’s market price of a share that is distributed to shareholders as dividends.
- Formula for the dividend yield
Dividend yield = Dividend per share (DPS)/Market value per share
Where:
- Dividend per share is the total dividends paid out over a certain period of time divided by the total number of ordinary shares outstanding.
- Market value per share is the current share price of the company.
- Example of the dividend yield
The current share price of company PDS is R50. Over the course of its past financial year, the company distributed dividends of R50 000. The number of ordinary shares outstanding is 70 000.
Dividend yield = (R50 000/70 000)/R50
= 0.71/R50
= 0.01420
= 1.4%
The dividend yield ratio for company PDS is 1.4%, meaning a shareholder would earn 1.4% on shares of the company in the form of dividends.
[i] Accentuations in citations from the Companies Act (Act 71 of 2008) are by the article writer.
