Paying cash dividends to its shareholders means that money is flowing out of a company. But this is not necessarily a negative – it’s just the cost of doing business for a corporation. The trade-off of paying dividends is that a company has hopefully used its shareholders’ investments to grow. When a company pays cash dividends to its shareholders, these payments proportionately affect the company’s retained earnings statement as liabilities.
Dividends are considered liabilities, so distributing them reduces net income on the statement of retained earnings since this represents a reduction in the company's assets.
What Are Cash Dividends?
The hope of receiving dividends drives investors to purchase stock in a corporation. When the company turns a profit, it redistributes this wealth among its investors in the form of dividend payments, based on the guidelines established by its board of directors. Dividends may be paid in cash, stock options or even in property. Cash dividends are typically paid quarterly, although they may be paid monthly. A company that pays cash dividends, instead of stock or property dividends, is usually more established and not in the growth stage of startups and other early-infancy companies.
What Are Retained Earnings?
A company’s retained earnings are the net profits that it retains after it pays dividends to its shareholders. Commonly, a company uses its retained earnings to reinvest back into the business. For example, retained earnings may pay for new equipment, supplies or building expansion. A business may also use these funds to pay down debt. On a company’s balance sheet, retained earnings are listed in the shareholder’s equity column, where amounts are carried over from one period to another. For example, the amount of retained earnings left over at the end of the year will transfer to the beginning month or quarter of the following year as the beginning balance.
Impact on Retained Earnings Statement
Other names for a retained earnings statement are owners’ equity statement and shareholders’ equity statement. A company’s retained earnings statement can be a standalone statement, or it can be part of another statement, such as an income statement. In either case, the retained earnings statement can be a valuable tool for a company to prove its market strength, which, in turn, may attract potential investors.
When a company distributes cash dividends to its shareholders, its retained earnings statement is affected by showing a reduction in the company's assets. Cash dividends, unlike stock dividends, represent a loss of liquid assets because they reduce the amount of a company's cash flow. And if a company also experiences a net income loss because of depreciation or loss of sales revenue, its retained earnings statement may show a negative number.