Once a person hears the word dividend he simply understands it to be a profit or a reward, but why a company does profit sharing with its customers. Here are the answers:
A dividend is cash or reward which is given, for delivering returns to the equity shareholders, on the capital invested by them in the business. It is often a part of the profit that the company shares with its shareholders.
What is a Dividend Policy?
A company uses dividend policy to structure its dividend payout to the shareholders. Dividend decisions refer to the decision-making mechanism of the management to declare the dividends.
Why do we need to have a dividend policy?
These are the major reasons as to why do we need dividend policy.
1. Maximize the shareholder’s wealth
The company’s ultimate objective is to maximize the shareholder’s wealth. The shareholders invest in the company and the company should pay them in such a manner that they further continue to invest.
2. Fulfilling the financial needs of the company
If the shareholders continue to invest in the company, the company would have enough money to sustain in the competitive market.
Factors influencing the dividend decision that a company takes:
There does not exist a single dividend decision factor that can work for every organization.
- The earnings of the company and its prospects.
- The Company’s cash inflows, which includes its stability and liquidity requirements.
- Shareholder’s expectation towards dividend as a source of income.
- Stability in the dividend payouts, irregularity in dividend payout should be avoided.
- The tax considerations, as the company would be left with fewer profits after paying out the taxes.
- Restrictive covenants such as creditors, lenders, debenture holders because of them there is a huge impact on the decisions.
- Long terms payout decision of the company.
- Control policy of the company so that the shareholder’s control would be less in the company.
- Impact of the trade cycle
- Government policies as the government intervene in a particular industry and can restrict the issue of shares or debentures.
Forms of Dividend:
A dividend which is paid out in cash. It will reduce the cash reserves of a company.
Bonus shares are the shares in the company which are distributed to shareholders at no cost. It is not done in the place of cash dividend but in addition to a cash dividend.
How does a company approach towards the dividend policy?
Well, there are two approaches to the same:
- When the company thinks of itself first that is when it looks for profitable avenues for reinvestment and pooling the funds into the company and whatever remains is then distributed to the shareholders.
- When the company thinks of shareholders first that is it takes an active decision of distributing the dividend in a planned and strategic manner.
What patterns do the companies follow while paying out dividends?
Stable Dividend Policy
The company decides to pay periodically a fixed amount of dividend to the shareholders. Even when the company incurs loss or generates high profit, there is no change in the dividend paid.
Regular Dividend Policy
A certain percentage of the company’s profit is allowed as dividends to the shareholders. When the gain is high, the shareholders’ earnings will also rise and vice-versa.
Irregular Dividend Policy
The company may or may not pay dividends to the shareholders. As per their priorities, the top management i.e., the board of directors solely take all dividend decisions.
No Dividend Policy
The company has no intention of declaring any dividends to its shareholders. The company always retain its profits to fund further projects.
What is a Sound Dividend Policy?
When the company is at the initial stage and it earns little profit, then it should give lower dividends to the shareholders.
When the company is growing it should provide a dividend to the shareholders in a proportionate manner.
When the company can survive in the market, it should provide a stable dividend to its shareholders.
What will be the impact of dividend decision on the share prices of the company?
If the company is paying dividends regularly, there is a pressure for maintaining the stability in the dividend payout. If it does not pay dividends even for one year and retains the funds for capital investment then it may prove hazardous for the company.
In cases of the company which has no stability in dividend policies, when the company does declare a dividend, the share prices will rise before the ex-dividend date. On dividend declaration more and more people invest by buying its shares, these shares are then sold. This is then followed by a fall in the share prices. It would result in great volatility.
A company’s dividend decisions and policy depict its future and financial well-being. Dividend payout policies are considered to be a bridge between the company and shareholders for profit-sharing. It would be difficult for investors to know the intentions of the management if the management does not have a sound dividend policy.
The dividend policies of an organization also result in a significant bearing on the market value of stocks, it also impacts the valuation of the company. Hence, it needs to be systematically framed and implemented.