This is no different than a company going into bankruptcy and liquidating its assets to pay off creditors.In this case, the company is paying investors back their original investments.
In effect, it shrinks the size of the company by reducing the capital accounts or equity by distributing it to the shareholders.To understand how a liquidating dividend works, you have to understand how a regular dividend works.A regular dividend is the distribution on profits or retained earnings for a period.This is the amount of money the company has earned in addition to the original amount of money the shareholders invested to start the business.In other words, this is a return on the investors investment in the company.The business must be profitable or have a positive retained earnings account in order to make a regular dividend.
A liquidating cash dividend, on the other hand, occurs when the company doesnt have enough profits or built up retained earnings to fund a cash distribution.
Its called a liquidating dividend because it takes money out of the company without sufficiently replenishing it with profits.
A company will issue this type of payment to shareholders if the company is claiming bankruptcy or ceasing business operations.
Shareholder company share-count determines a shareholder's payment amount.
A liquidating cash dividend is a distribution to that returns some of the original investment to the owners.
In other words, a liquidating cash distribution gives some of the investors investment back to them.