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Investment is allocation of savings with the main objective of gaining some returns. An investor decides to invest his/her earnings instead of keeping them in lockers with the aim of creating wealth.  The returns earned by an investor in securities market is mainly in two forms – dividend and interest.

Dividend is a form of a reward to the shareholders of an organization for the capital they have invested in the organization. A company either decides to retain its earnings or to distribute it to shareholders in the form of dividend. Retained earnings are ploughed back into the organization for growth purposes. Dividend distribution leads to maximization of shareholder’s wealth. Shareholder’s wealth is dependent on market price of company’s stocks which usually increases when higher dividends are paid. Investor sentiment about the company’s stocks remain positive if company decides to distribute a part of its profits by paying them dividend.

Interest is a return received by investors on debt instruments such as debentures and bonds. Interest is a charge against profits of an organization which means it is to be paid regardless of a company incurring profits or losses. It is paid at a fixed percentage which is decided when the security is purchased. It is paid for a specific period of time.

Differences between dividend and interest

1. Nature: Dividend is appropriation of company’s profits and are distributed when a company incurs profits. But interest is to be paid compulsorily both in case of profits or losses.
2. Paid to: Dividend is paid to preference shareholders and equity shareholders. Interest is paid to creditors, lenders and debenture holders.
3. Calculations: Dividend varies according to the dividend policy and strategic plans of the company, whereas the percentage of interest is fixed and is paid either simple or compounded.
4. Tax: Dividend received from an Indian company is exempt from tax because the company has already paid a Dividend Distribution tax (DDT). Tax shield is available on interest income as it is a tax deductible expense. Thus from the point of view of company, payment of dividend brings in extra burden in the form of Dividend Distribution Tax.
5. Treatment in financial statements: Dividends are shown as a reduction in retained earnings in the Equities section of Balance Sheet. Payment of dividends is also shown as an outflow in financing activities of Cash Flow Statement.

Interest is treated as an expense in the Income Statement of a company. If the interest is accrued but not yet paid then this item is shown under the head “Current Liabilities” in the Balance Sheet.

Which one is better?

Interest is paid on debt thus it helps an organization in earning greater financial leverage. Dividend leads to wealth maximization of shareholders thus lead to a business running well. Interest payments are given higher priority than dividends. The investors who desire fixed returns must invest in debt instruments while those who want higher returns should go for equities. Hence which one is better is dependent on the priorities and preferences of the investor.

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