Dividend Policy : Meaning, Types, Determinants & Constraints ( Complete Notes pdf )
Dividend Policy is another important concept of Financial Management. To understand Dividend Policy, you must be aware of the term DIVIDEND. So let’s stat from the zero level…
Meaning of Dividend
This Article Includes
- Meaning of Dividend
- Types of Dividends
- Introduction to Dividend Policy
- Determinants of Dividend Policy
- 1. Dividend Payout Ratio
- 2. Stability of Dividend
- 3. Legal, Contractual and Internal Constraint
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- Determinants of Dividend Policy
Dividend refers to the portion of a firm’s profit ( after tax ) which is distributed among the owners or shareholders. The profit which is not distributed is known as retained earnings.
Therefore, it is the reward of the shareholders for the investment made by them in the shares of the company.
Types of Dividends
1. Cash Dividends
Cash Dividend refers to the dividend that is distributed to the shareholders from the earnings of a firm in the form of cash. Then, it is the choice of the shareholders, either to reinvest the money or to break out. Cash Dividends are taxable.
2. Stock Dividends
Stock Dividend refers to the dividend that is distributed to the shareholders from the earnings in the form of additionally fully paid shares. In stock dividends, firm’s cash is conserved. Also, these dividends are not taxable until the shares are sold.
3. Property Dividend
Property Dividend refers to the dividends that are paid to the shareholders of the firm in the form of some property. For Example, Firm shipping the products made by it to the shareholders. Property dividend is the alternative to cash and stock dividend. These dividends are taxable at the fair market value of the property.
4. Liquidating Dividend
Liquidating Dividend refers to the dividends that are paid to the shareholders by the firm at the time of partial or fully bankruptcy or while ceasing business operations. Usually, the shareholder is paid from the firm’s capital base as per the number of shares the owe. This type of dividend is non-taxable.
5. Scrip Dividend
Scrip Dividend refers to the dividends that are given to the shareholders by the firm in the form of promissory notes or certificates in which the firm promises to pay the shareholders a decided amount after a particular time period. The firm issues scrip dividends due to the shortage of liquidity. This type of dividend is also an alternative to cash and stock dividends.
Introduction to Dividend Policy
The policy that a firm uses to decide, how much portion of the firm’s net earnings or profit after tax must be paid to the shareholders in the form of dividends to keep them happy is known as Dividend Policy.
Determinants of Dividend Policy
1. Dividend Payout Ratio
Dividend payout ratio refers to the percent of net profit to be distributed as dividends by the firm to the shareholders. The remaining part of the earning is held by the firm for its further growth.
DP Ratio = Dividend paid to shareholders / Net profit of the firm
The decision regarding DP Ratio is the critical decision and must be taken after considering the following factors:
The liquidity position of a firm is considered while deciding the DP Ratio, as earnings don’t mean that the firm must have earned hard cash. Also, the firm usually needs cash in hand for the payment of debts, purchasing raw material and even for the emergency.Thus, liquid position plays a significant role.
If a firm is having growth plans for near future, it will adopt low DP Ration to make the funds available for those growth plans for no extra growth. But if a firm doesn’t have any growth plans for the near future, then it may adopt high Dividend Payout Ratio.
The firm must control the dividend payout ratio. Making Dividend Payout Ration too low or too high may create the problems for the firm.
- If the Dividend Payout Ration is low, then the firm will accumulate enough cash to expand the business or for emergency needs, but that make shareholders unhappy.
- If the Dividend Payout Ratio is high, then the firm may have to gather funds from outside resources, debts, from banks, private institutions, etc, that will give rise to the risk factor.
2. Stability of Dividend
Stability of dividend refers to the consistency or lack of variability in payment of dividends to the shareholders. Stability of dividend means how regular or stable is the dividend policy of a firm over a period of time.
Shareholders prefer stable dividends along with some growth in those dividends. If a firm is able to pay dividends in a such a way then the cost of shares will increase.
I. Constant Dividend Payout
Constant Dividend Payout is not generally adopted by a firm. Constant Dividend payout ratio means giving a particular fixed percentage of the total earnings after profit as dividends. So, in this case, if the earnings are high, shareholders will get higher dividends but if the earnings are low, for a particular period, then the dividends will be low.
Firm sometimes fix a particular amount per share as a dividend to shareholders irrespective of the earnings of the firm. This type of dividend is known as Constant Dividend Per Share. Such type of dividends are favoured by shareholders as it enables them to plan their future investment and gives a clear picture of their invested money.
III. Steady Dividend Plus Extra
Firms having the policy of steady or constant dividends when pay some extra amount to the shareholders along with the steady dividends due to any reason, like better earnings of the firm for that time period, silver jublee of the firm, etc. This type of dividend is known as Steady Dividend or Consistent Dividend Plus Extra.
3. Legal, Contractual and Internal Constraint
The dividend declaration policy must follow Companies Act, 2013, while along with this, separate contractual provision must also be completed. Also, internal constraints are also taken into consideration while deciding dividends.
I. Legal & Contractual Constraints
1. Companies Act 2013, sections & instructions must be followed.
2. Dividend can be paid either as :
- Final Dividend, that is paid after the annual general meeting of the firm after analyzing the earnings.
- Interim Dividend, that is paid in between the two Annual General Meetings of a firm, if firm seems to generate expected profits.
3. Dividend is paid fromt he earnings of present year.
4. Once the dividend amount is declared, that must be paid to the shareholders within 30 days.
II. Internal Constraints
Following are the internal constraints that affect in dividend policy:
- Dividend Distribution Tax
- Availability of funds, etc.
That’s all for the Dividend Policy in Financial Management. Still left with any doubts regarding the topic ?? Just contact us by commenting down or through our facebook page, and we will reply to you 🙂