Interest vs Dividends
We hear so much about interest and dividends as investors in different companies but we rarely pay attention to the basic differences between these two terms. Majority of people think of interest as the money paid by a company to its lenders and dividend as the sharing of profit that a company earns with its shareholders. But there is much more to the concept of interest and dividends than this, and will be explained in this article.
Interest is the return on investment that a lender charges from his client on the money or loan that he has lent. When a company is expanding or needs money to invest in plant and machinery, it has the option to raise capital through getting loans from lenders like banks or even private investors. The amount of money paid by the company that is decided in terms of percentage of the money lent is known as interest. A company also pays interest on bonds it issues to public. All the money that a company pays in the form of interest to debtors and bond holders is considered as an expense of the company and it reduces the net income of the company, and thus its taxable income. While the cash with the company is reduced when it has to pay interest to various lenders, it also saves some money in the form of reduced income tax.
If a company makes profits, it has to share a part of these profits with its shareholders. The amount of dividend is not fixed and keeps on varying with varying profits. If a company is suffering losses or is making very little profits, it is unlikely to issue any dividends. Mostly dividends are in the form of cash, but sometimes they are paid in the form of stocks of the company also.
Dividends are not an expense of a company and as such they do not reduce the net income of the company. Dividends are like ownership returns that you get when you own shares of a company. Dividends can be declared yearly, half yearly, quarterly, or even monthly.
Difference Between Interest and Dividends
• Both interest as well as dividends are liabilities of a company and it has to pay them to debtors and shareholders respectively
• Interest is fixed and specified in the terms and conditions of debt or bonds; dividends can vary depending upon profits of the company.
• Interest is considered as an expense of a company and has the effect of reducing tax liability of a company when it is paid
• Dividends are not considered expense of a company