Previously, the term “dividends” was introduced and discussed. Dividend distributions reduce the net assets of a company.In , a number of expenses are listed but no dividends are mentioned.Why are dividend payments not included as expenses on an income statement? Answer: Dividends are not expenses and, therefore, must be omitted in creating an income statement. Such payments obviously reduce the amount of net assets owned or controlled by a reporting company. However, they are not related in any way to generating revenues. A dividend is a reward distributed by a company (through the decision of its board of directors) to the owners of its capital stock. Thus, a dividend is a sharing of profits and not a cost incurred to create revenues. In , Davidson Groceries reports net income for the year of $230,000. The board of directors might look at that figure and opt to make a cash dividend distribution to company owners. That is one of the most important decisions for any board. Such payments usually please the owners but reduce the size of the company and—possibly—its future profitability. An income statement reports revenues, expenses, gains, and losses. Dividend distributions do not qualify and must be reported elsewhere in the company’s financial statements.
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Likewise, only the analysis of all information conveyed by a complete set of financial statements enables an interested party to arrive at the most appropriate decisions about an organization. Some creditors and investors seek shortcuts when making business decisions rather than doing the detailed analysis that is appropriate. Those individuals often spend an exorbitant amount of time focusing on reported net income. Such a narrow view shows a fundamental misunderstanding of financial reporting and the depth and breadth of the information being conveyed. In judging a company’s financial health and future prospects, an evaluation should be carried out on the entity as a whole. Predicting stock prices, dividends, and cash flows requires a complete investigation. That is only possible by developing the capacity to work with all the data presented in a set of financial statements. If a single figure could be used reliably to evaluate a business organization, creditors and investors would never incur losses.
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