What Is A Dividend?

The word "dividend" comes from the Latin word "dividendum" meaning a thing to be divide. The definition of a dividend as it relates to finance is:

1. A pro-rata share in an amount to be distributed
2. A sum of money paid to shareholders of a corporation out of earnings
 

An investor who is holding common stock ie. ordinary shares in a company will receive a return in one of two ways: capital gains which come from price changes and dividends. They are payments made by a corporation as a portion of corporate profits. When a corporation earns a profit, that money can be re-invested in the business which is called retained earnings , or can be paid to the shareholders as a dividend. Usually, corporations retain a portion of their earnings and pay the remainder as a dividend.
 

There are practical limitations to a company paying out a dividend. A firm must have distributable reserves on the balance sheet to be able to pay a dividend. A company may therefore dip into the undistributed profits of previous years.
 

A firm also must have the cash available to pay out. Any experienced investor will know that profits do not necessarily mean cash, because a company can have last year's profits but negative cash flow, and that means problems to pay dividend to it shareholders.
 

But when company once start to pay dividends, it is difficult for them to stop, because their dividends acctracted some mutual funds that select their investments partly on dividend policy and history of a company, and missing one or more payments can lead to funds selling their holdings. These sales can lead to an imbalance in the supply and demand of stock and a fall in the price in the market.