Dividends are those earnings which are distributed among stockholders of a company. These earnings are paid either in cash or in stock, generally on a quarterly basis and may be paid only out of retained earnings, not from invested capital. Dividends are only paid when the company’s profitability can support this payout. The more and regular the company’s profitability, the regular the payment of dividends. The amount of dividend paid for each share depends on the organization’s policy towards them. Organizations are not obligated legally to pay dividends, but to keep the investors interested in the organization, the management pays out dividend, though the percentage of dividends per share can differ from year to year, as it depends on the profitability of the company.
There are other factors also which decide the payment of dividend in the company. These include corporate growth rate, restrictive covenants, earnings stability, degree of debt and tax factors.
Dividend Policy is important in addressing certain factors such as:
Influences the investors’ decisions: General public which wants to invest in an organization will look for two factors, the profitability of the company and the overall growth rate of the company. Profitability will determine the company’s dividend payout ratio and of course growth rate of the company is also an important factor. So, a company seeking good investor support shall have to decide a dividend policy which can keep the investors happy.
Impact on finance program and capital budget of a company: Dividend policy is one of the factors influencing a company’s finance and capital budget. The profits of a company pertaining to a quarter or a year are generally taken into consideration. These profits are either saved as retained earnings or they can be paid out. Retained earnings are good source of generating internal finance. A company cannot in many circumstances save 100% of the profits or payout 100% of the profits as dividends. Many a times, it needs to strike a balance between dividend payout ratio and retained earnings ratio. The percentages can be 50: 50, 60:40, 70:30, etc.
A company cannot afford paying out high dividend rates every year. Instead, it can adopt a low dividend payout ratio which can be helpful during the years of low earnings as well.
High dividend ratio will affect the cash flow of the company. Companies with poor liquidity ratio cannot payout dividends because of less availability of cash.
High dividend ratio will decrease the stockholders’ equity, since dividends are paid from retained earnings. The result is higher debt to equity ratio.
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