Dividend-paying stocks are preferred by investors who want to develop a steady source of income. However, most investors only know about the final or regular dividends paid by the issuer. They should also understand the concept of interim dividends and how they are distributed. Some beginners in the stock market might not even be familiar with the concept of dividends. It is essential to understand these basics before investing in the stock market. Continue reading to understand the concept of interim dividends in detail.
What Are Interim Dividends?
Investors prefer to invest in stable or sustainable companies to earn dividends. A stable company is likely to make profits at regular intervals via its operations. It distributes a part of the profit to the shareholders, as they have ownership stakes in the company. A company can distribute two types of dividends to shareholders, which are regular/final and interim dividends. Usually, public companies conduct Annual General Meetings (AGMs). A particular company will propose the dividend rate to shareholders in the AGM. It will also present the audited financial statements to the shareholders. Final dividends are distributed based on the approval of shareholders and company officials.
Interim dividends might not wait till the annual meeting. A company might issue it to shareholders before the AGM. Final dividends are usually paid at the end of the financial year. On the other hand, interim dividends are distributed multiple times throughout the year. However, most companies prefer distributing interim dividends quarterly or half-yearly. Also, the rate of dividends is lower than for final dividends. Many companies issue it once every quarter on the dividend day. Interim dividends might also be bonus issues (additional shares) instead of cash. It often helps shareholders ride out seasonal fluctuations and gain confidence in the issuer.
What is a Dividend?
Some of you might be beginners in the stock market. In such a case, understanding what a dividend is is essential. When you purchase stocks in a company, you are getting ownership stakes in the company. It means the company will provide you with a part of the profit it makes. The payments made at regular intervals to shareholders are called dividends. The dividend payout will depend on the number of shares you hold. It is crucial to note that not all public companies pay dividends to shareholders. The dividend payout will depend on the company’s profitability and financial position.
Dividends are not paid abruptly or suddenly to investors. Usually, companies pay final dividends towards the end of the financial year. Most of you might think dividend payouts always happen in cash. Besides cash dividends, a company might also issue additional shares to stockholders on a pro-rata basis. The additional stocks distributed among existing shareholders are also called bonus issues. Some companies might even distribute preferred stocks as dividends. There have been cases where companies have distributed property dividends and debt securities to existing shareholders.
Every dividend-paying company will have a strict policy. The board of directors, business owners, and majority shareholders decide the dividend policy. The dividend rate, frequency of payments, type of dividend, and other details are included in the policy. Let us now get back to understanding what interim dividends are with an example.
Interim Dividend Examples
Let us say a company named ABC announces a dividend for existing shareholders on 19 October 2023. The decision came shortly after the company published its financial reports for the second quarter (July to September). The company has decided on a dividend rate of 10%. The face value of the share is Rs 10 per share. It means the dividend will be INR 1 for each share held (10% of 10). Also, the company has issued a record date of 1 November 2023 for the dividend payout. It means that shareholders with shares of ABC on the record date will be eligible for the dividends.
The above was an example of a dividend in cash format. There are also instances of interim dividends in the form of bonus issues. For example, the same company, ABC, might announce the next dividend before the end of the financial year in the form of bonus issues. Existing shareholders on the record date will receive additional shares in bonus issues. Shareholders will add more ABC shares to their portfolios without spending any money. The decision on the type of dividend is made by the board of directors, majority shareholders, and other prominent figures in the company.
How to Calculate Interim Dividend?
The calculation of interim dividend for a company follows this formula:
Interim Dividend = (Profit After Tax – Previous Dividend) * Dividend Ratio
In the above formula, profit after tax is considered for an interim, which is part of a fiscal year. The previous dividend paid to shareholders is also considered. The dividend ratio denotes the portion of the profit the company is willing to give to shareholders.
Let us understand the calculation of interim with an example. Let us say that a company named ‘ABC’ has made an interim profit of INR 10,00,000. The company has already paid a final dividend of INR 4,00,000 in the previous fiscal year. Also, the rate of the interim dividend is 0.30. It means the company is willing to give 30% of the interim profit to shareholders in the form of dividends. In such a case, the amount of the interim dividend will be:
Based on the formula, ABC can distribute INR 1,80,000 among its shareholders in the form of interim dividends. The dividend for a particular shareholder can also be calculated using this formula:
Interim Dividend of a Shareholder = Ownership Stake Percentage * Total Interim Dividend Amount
How is Interim Dividend Funded?
Companies need funds to pay interim dividends to shareholders. As you already know, these dividends are paid based on profits made within a given period in the fiscal year. However, it does not mean that the funds for them are generated from the company’s current profits.
When a company distributes final or regular dividends, it uses profits made in the current fiscal year. Since all financial reports are finalised and audited at the end of the fiscal year, a company can use current profits to pay final dividends. However, the same is not the case with interim dividends, as current profits are yet to be circulated and finalised. Companies use the available sources to fund them for shareholders.
Most companies use their cash reserves to fund these dividends. Retained earnings are usually used for this purpose. Retained earnings of a company include the profits made in the previous fiscal year. Profits of previous fiscal years are audited and circulated in the cash flow. Retained earnings from the previous fiscal year(s) are left after final or regular dividends have been distributed. Since they are undistributed profits from previous fiscal years, they are used to fund them. Some companies might also use cash flow from operations.
Some companies might choose to distribute them when they do not have significant retained earnings or reserves. In such a case, the company might borrow funds or take a loan. Companies might even indulge in the sale of unused assets to fund them.
In a Nutshell
Interim dividends are distributed quarterly or half-yearly by companies to their shareholders. Companies might even suddenly distribute these dividends due to high profits in a given time frame. These are different from regular or final dividends, which are distributed at the end of the fiscal year. Beginners in the stock market must also understand how to calculate interim dividends.
Stock investors can choose stocks that pay both final and interim dividends. Investors can build a stable source of income by investing in dividend-paying stocks. Not to forget, you will hold stocks for the long term to receive dividends, thus benefiting from capital appreciation. Learn more about interim dividends now!