Publicly traded companies have the ability to reward investors with dividends, which are cash or stock distributions, using excess cash flow. Dividends are only considered, however, once other financial obligations are met. If annual profits not only meet but exceed budget requirements, the profits become available earnings that a company's management team can use as dividend distributions. The decision must have support by a company's board of directors, and the announcement is usually made in conjunction with the release of a financial statement.
The amount of available profits that a company has is used to generate the value of earnings per share (EPS). This is a measure of profitability or another way of illustrating net income that is earned during a period. To get this number, the available earnings amount as well as outstanding common shares are used in a calculation. Available earnings divided by outstanding shares leads to the bottom-line number, or EPS, based on certain accounting standards.
Companies report earnings, which are a measure of profits, quarterly and yearly. Once annual financial obligations, such as tax payments and preferred-stock dividends, have been accounted for, available earnings may exist. A company's management team is faced with options if excess cash flow is generated. These additional profits can essentially be used in one of two ways, including toward the operation of the company or as a financial reward to investors in the form of dividend payments.
Financial conditions must be extremely favorable for available earnings to be distributed to shareholders. If profits fall short or are only equal with financial obligations, available earnings are insufficient to reward investors. In fact, if profits are not enough to fuel a company's operations or growth plans, the management team may need to turn to the equity capital markets to raise additional money. One way to accomplish this is to sell additional equity in the stock market in a follow-on offering. It is only when profits surpass other commitments that additional earnings can be transformed into rewards for investors.
An organization is not obligated to use excess profits to pay dividends. Companies in high-growth industries, such as technology, for instance, must often reinvest in the business in order to remain competitive. In this case, available earnings might be used for internal growth purposes rather than as paid distributions to investors. Some companies are conducive to slower growth, such as electricity providers, and may be more likely to use available earnings to pay investors' dividends rather than toward expansion.
