What impact do stock dividends have on cash reserves?

Stock dividends are a distribution of additional shares of a company's stock to its existing shareholders, rather than distributing cash. When a company issues stock dividends, it allocates shares from its retained earnings or reserves rather than from its cash balance. As a result, the company's cash reserves remain unaffected by issuing stock dividends.

The correct understanding of stock dividends is that they do not involve any cash outflow, and therefore cannot decrease cash reserves. Instead, they only alter the composition of equity without impacting the liquidity of the company. The issuance of stock dividends can also be seen as a way for companies to reward shareholders without depleting cash reserves, thereby maintaining liquidity.

In the context of the options provided, the second choice, which states that stock dividends do not affect cash reserves, accurately reflects the nature of stock dividends by indicating that cash reserves remain stable after their issuance. This understanding is key for financial management professionals in evaluating corporate actions and their implications for liquidity and shareholder equity.