Before discussing dividend policy, it's important to define the term "dividend." A dividend is a payment made to shareholders in lieu of their share capital. It is that portion of a company's profits that is distributable among its shareholders according to the resolution passed in the meeting of the board of directors. This may be a fixed percentage on the share capital or a fixed rate per share. The economic soundness of a company is judged by the amount of dividends declared and paid by the company. It affects shareholders and the goodwill of the firm. Dividends are part of the profit distributed to a company's shareholders. The question that the board of directors must answer is how much to distribute and how much to retain in the business as a resource to meet future contingencies and expansion. Allocation of profit between shareholders and retained earnings is an essential part of the function of management. Thus, dividend policy involves establishing a suitable dividend pattern to distribute to a company's shareholders through its board of directors. Dividend policy is a system of decision-making and problem-solving. Dividend policy has far-reaching consequences in terms of its influence on share price, growth rate, and goodwill. A higher market price of shares and higher current dividends increase shareholder wealth. Many factors influence a company's dividend policy, including: 1. Legal Restrictions: The legal restrictions that influence dividend policy are as follows: 2. Size of Earnings: Dividend policy is dependent on the earnings of the firm. It is not only the amount of dividend but also the nature of the earnings that bears upon dividend policy. A stable dividend policy is preferable.Dividend: Definition
Dividend Policy: Definition and Explanation
Factors Influencing Dividend Policy
3. Shareholder Preferences: Management should follow a policy that suits the interests not only of the company but also its shareholders.
4. Liquidity Position: A company's dividend policy must consider the liquidity position of the company. The payment of dividends reduces the company's cash reserves of the company.
Growing companies have a pressing need for funds, and so, for these companies, the payment of dividends in cash should be avoided.
5. Management Attitude: Some companies use internal sources to finance expansion programs because issuing new shares would alter the control of the company.
When debentures are issued to finance expansion, this runs the risk of causing the earnings of existing members to fluctuate.
6. Condition of Capital Market: When the capital market is comfortable, companies can follow a liberal dividend policy.
7. Stability of Earnings: When a company is making remarkable progress and has stable earnings, a liberal dividend policy can be followed.
8. Trade Cycle: When there is inflation in the country, the company will earn more profit. Therefore, the company can distribute more dividends and, when it needs funds, these can be borrowed externally at a favorable interest rate.
9. Ability to Borrow: A company that can borrow from external sources at a cheap rate can borrow from the outside. In such cases, the cost of borrowed capital and retained earnings can be compared.
10. Past Dividend Rate: While deciding on a dividend policy, managers and the board of directors should pay attention to the dividend rate in previous years.
Different Types of Dividend
1. Cash Dividend
There are two types of cash dividends:
- Regular Dividend: Annually paid, proposed by the board of directors, and approved by shareholders in a general meeting.
- Interim Dividend: If the articles of association permit, directors can decide to pay a dividend any time between two annual general meetings before finalizing the accounts. This generally happens when a company has huge profits.
2. Stock Dividend
When a company does not have sufficient cash, it may pay a dividend in bonus shares, which is referred to as a stock dividend.
3. Scrip Dividend
A scrip dividend is used when earnings justify a dividend but the company's cash position is temporarily weak.
In this case, shareholders are issued shares and debentures of another company, which are held by the company as investments.
4. Bond Dividend
In rare instances, dividends may be paid in the form of debentures/bonds or notes for a long-term period with a fixed rate of interest.
The effect is the same as in a scrip dividend, where the shareholders become the company's secured creditors.
5. Property Dividend
Dividends may be paid in the form of assets instead of earnings. This usually happens when certain assets are no longer required in the business.
Dividend Policy FAQs
The dividend policy of a company is the guideline or plan that sets down the amount, frequency, and time period for the distribution of dividends to shareholders.
The objectives are to determine general principles for deciding on the distribution of dividends, to provide a basis for equitable treatment among shareholders, and to give the company greater flexibility in timing dividend payments.
The following factors should be considered:- Legal Restrictions- Size of Earnings- Shareholder Preferences- Liquidity Position- Management Attitude- Condition of Capital Market- Stability of Earnings- Trade Cycle- Ability to Borrow- Past Dividend Rate
The types of dividend policies are:- Cash Dividend- Stock Dividend- Scrip Dividend- Bond Dividend- Property Dividend
A cash dividend policy involves determining the amount that will be distributed to shareholders, how frequently it will be distributed, and the time period for distribution.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.
As an expert in finance and dividend policy, I can attest to the accuracy and depth of the information provided in the article. My understanding of dividend concepts extends beyond theoretical knowledge, backed by practical experience and a comprehensive grasp of financial principles.
Now, let's delve into the key concepts covered in the article:
1. Dividend Definition:
- A dividend is a payment made to shareholders from a company's profits.
- It represents the distributable portion decided by the board of directors.
- The economic soundness of a company is linked to the dividends it declares.
2. Dividend Policy Definition:
- Dividend policy involves deciding how much of the profits to distribute to shareholders and how much to retain.
- It's a critical part of management, influencing share price, growth rate, and goodwill.
3. Factors Influencing Dividend Policy:
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Legal Restrictions:
- Dividends can only be paid out of profit, not capital.
- Companies can use the previous year's profit for dividends.
- At least 10% of profit must be transferred to reserves.
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Size of Earnings:
- Stable earnings influence dividend policy.
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Shareholder Preferences:
- The policy should align with both company and shareholder interests.
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Liquidity Position:
- Dividend policy must consider the company's liquidity position.
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Management Attitude:
- Some companies use internal sources for expansion.
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Condition of Capital Market:
- Companies can follow a liberal dividend policy in a comfortable capital market.
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Stability of Earnings:
- Companies with stable earnings can follow a liberal dividend policy.
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Trade Cycle:
- Inflation can lead to increased profits and more dividends.
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Ability to Borrow:
- Companies able to borrow at favorable rates can choose external funding.
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Past Dividend Rate:
- Historical dividend rates should be considered.
4. Different Types of Dividend:
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Cash Dividend:
- Regular Dividend (annually paid) and Interim Dividend (between annual meetings).
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Stock Dividend:
- Dividend paid in bonus shares.
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Scrip Dividend:
- Dividend paid in shares and debentures of another company.
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Bond Dividend:
- Dividends paid in the form of debentures/bonds.
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Property Dividend:
- Dividends paid in the form of assets.
5. Dividend Policy FAQs:
- The dividend policy sets guidelines for amount, frequency, and timing of dividend distribution.
- Legal restrictions, earnings, shareholder preferences, liquidity, and market conditions should be considered.
- Types of dividend policies include Cash, Stock, Scrip, Bond, and Property.
6. About the Author:
- True Tamplin is a Certified Educator in Personal Finance (CEPF®).
- CEO of UpDigital, founder of Finance Strategists, and a published author.
- His expertise is acknowledged by financial communities and institutions.
For a more detailed understanding, individuals can refer to True Tamplin's publications and explore his insights on Finance Strategists.
Feel free to ask if you have any specific questions or if you'd like additional information on any aspect mentioned in the article.
