The Difference Between Dividends And Interest Rates

These two terms are prevalent while making investment decisions, but very few understand clearly the distinction between these two terms, this is because these terms sound like they should mean the same thing, but they don’t and you must understand the difference.

Interest is the amount(usually money) a borrower pays at a fixed predetermined rate and specified date to the creditor for the utilization of the money.

This means that when an individual or corporation seeks a loan from creditors for different purposes when returning the money loaned, such individual or corporation has to return it with interests.

This happens mostly when a certain company wants to expand its business or establish a new venture, they apply for loans from various financial institutions. It then owes the principal amount borrowed and the interest to be paid at regular intervals regardless of whether the company is making profits or not. The rate at which the interest is charged is known as the interest rate, and it can be paid on an annual basis, monthly or quarterly depending on the agreement between both parties. In simple terms, Interest is a price (better to say charges), a borrower pays a lender for letting the former use the money latter has had.

Dividends, on the other hand, refer to the money or shares distributed to the shareholders of a company according to the amount of capital they have invested in the company.

This simply means that upon purchasing the shares of a company, the shareholder is entitled to a portion of dividends which can be determined annually, semi-annually, or quarterly at the management’s discretion when the company makes a profit. If the company is not making profits, the management can decide to pause the distribution of dividends for a while until the company starts making profits again.

Companies can issue dividends after a unanimous decision is taken by the board of directors when the company makes a profit because it is a percentage of profit the company shares with its shareholders.

Talking about shareholders, there are preference shareholders and equity shareholders. For preference shareholders, a dividend is mandatory because they’re paid even before equity shareholders are given a single penny. For equity shareholders, a dividend is only paid when the company decides to pay off the equity shareholders out of the profits earned after paying the debt holders and preference shareholders.

PROFIT BASED

Based on profit, interest is not paid based on whether profit is made or not, it is a financial obligation that needs to be honored by the borrower to the lender or creditor and if by chance, the borrower misses the repayment date, additional charges can be incurred depending on the lender.

MANDATORY

Payment of Interest is mandatory even if you earn the profit or not, but in the case of dividends, the payment of the dividend is optional as it is decided by the board of directors in the company.

Sometimes the company might decide to reinvest the money in future expansion and growth, in that case, shareholders might not receive dividends.

Other differences include:

1. Interest is the additional charge against the money lent to the borrower, while a dividend is the percentage of profit distributed.
2. Interest is paid to the lenders and creditors such as individuals or financial institutions, while the dividend is paid to the preferred shareholders and equity shareholders of a company.
3. Interest is a major determinant of how much profits/losses a company would make, while Dividend determines how much profits would be reinvested into the business.
4. Interests are tax-deductible, whereas dividends are not tax-deductible.

In conclusion, Dividends and interests are two different terms but major components of the business, therefore, before deciding on any type of investment, one needs to check the tax effects and the potential income gain.