Certified Financial Management Specialist Practice Exam

What are dividends?

1. Payments made to employees for performance

2. Payments made to investors from free cash flow

3. Funds set aside for company reinvestment

4. Expenses incurred for research and development

The correct answer is: Payments made to investors from free cash flow

Dividends are defined as payments made to investors from a company’s free cash flow, which reflects the actual cash available to distribute to shareholders after accounting for operational expenses and necessary reinvestment in the business. They represent a share of a company's profits that are distributed to its shareholders as a return on their investment. This distribution is typically paid out in cash, but can also be issued in the form of additional stock. Understanding this concept is crucial for investors, as dividends can serve as an indicator of a company's financial health and its commitment to returning profits to shareholders. Companies that generate consistent free cash flow often choose to distribute a portion of it as dividends, which can make their stock more attractive to income-focused investors. This approach aligns with shareholder interests, especially for those seeking ongoing returns from their investments rather than just potential capital gains. In contrast, payments made to employees pertain to compensation and performance bonuses rather than to investors, funds set aside for company reinvestment suggest intentions for growth and expansion rather than direct payouts, and expenses for research and development are costs associated with innovation and product development, not income distributions to shareholders.