Why do we report dividend payments as financing activities on the cash-flow statement?
CASH FLOW STATEMENT: According to IAS 7 Statement of Cash Flow the payment of interest and/or dividends may be classified under operating, investing or financing activities. Whichever activities the firm select to treat interest/dividends, it must be consistent in its reporting from period-to-period. If in this period dividend payment was reported under operating, it must also be reported under operating activity in the subsequent report (period).
The function of the Cash Flow Statement is to provide a summary picture of the flow of cash or cash equivalent (receipt and spending) in three main activity categories: (i) operating, (ii) investing, (iii) financing. As long as the interest or dividend receipt/payment is put in one of the three categories consistently throughout reporting periods, the practice is considered conforming to the standard of practice under IAS.
REFERENCES: See attached IAS 7.
In my opinion, dividend is the reward to shareholders in return of their investment. In other words, dividend is the cost of equity. Cash flow from financing activities can be determined by taking the change in long-term debt, change in stockholders equity except change in retained earnings and dividend paid. So important thing in it is that do not take change in retained earnings while computing the cash flow from financing activities. Why? Because change in retained earnings is the sum of net profit after taxes + dividend paid. The net profit after taxes are the part of cash flow from operating activities whereas dividends are the part of financing activities because they represent the cost of equity.
In my own view I understand Dividend Payments are financing activities on the Cash-Flow Statement because they go to the entity stakeholders who finance the business.
Independent from regulation by IFRS or even local GAAP, for me it appears to be a systematic and logical procedure to qualify a dividend payment as cash outflow to shareholders and at the same time as a definancing activity. If you consider a firm's ability to generate value by free cash flows of the future, than the payment of dividends is characterized as a definancing acitivity by which the generated value is distributed or shared with the company's stockholders.
The reason why dividends classified in financial activities is because the payment of dividends to owners has an impact on the amount of cash in the company (impact on the financial strength of the company as a repayment of the principal loan). It would not be okay that the dividends paid are classified as operating and investment activities as dividend payments not related to the business activities of the company and investment activities. On the other hand interest on loans fall in operating activity as loans are taken to be normally conducted business.
Cost of Capital
Just like interest on loans is return to lenders, dividends is rewards or payout to the shareholders for providing capital.
In SCF, Financing activities include the cash inflows from and outflows to investors; dividend paid is reported under Financing activities since it is considered a cash outflow to shareholders as dividend when the firm generates income. Notice that Dividend Received is reported under Operating activities.
it is purely a financial decision related matter not a routine matter as such. it may be declared or may not be. it always does not depend upon the size of profits lot of other things have to be taken into account for declaring dividend. so it is financial matter
Simply, we have cash-in flow and cash-out flow relatrd to financing activities. Having fina ce from equity capital represents financing cash-in flow. The same works for payment of dividends to stockholders; where it represents cash-out flow related fo financing activities.
Dividends are; the inevitable result of the investment process carried out by the investors. That is, they are targeting from behind the investment process to achieve profits. So it is natural that appear in financing activities in the statement of cash flows.
There are two strategies to consider:
1. The general philosophy is that dividend payments are considered to be Financing Activities because these are payments to the investors (shareholders) who actually are co-finincing the company. These dividend payments may be interpreted as "variable interests" to the investors of equity for their risk taken in the company (for the company, these represent a part of the cost of equity). Though, the company has per se no obligation to pay divedends; it is just a periodic circular decision if to do so or not (in contrary to the costs of debt financing, where the interests are determined by a contract).
2. But if the company has a kind of "commitmend / promise" to periodically pay dividends and this is actually implicitly expected by the investors, then it makes sense to treat the periodical occuring dividend payments as Operational Cash Flow. The key indicator for the company in this context is the Free Cash Flow: The company has a better transparency and control on its capability of generating Free Cash Flows.
What´s import: Once made a dicison whith which stategy to proceed, the company shall stick to it consistently.
You can find a hint on how a company can treat dividend payments by consulting IAS 7.34: "Dividend paid may be classified as a financing cash flow because they are a cost of obtaining financial resources. Alternatively, dividends paid may be classified as a component of cash flows from operating activities in order to assist users to determine the ability of an entity to pay dividends out of operating cash flows."
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