CA GOLS

Dividend Policy

Meaning of Dividend:

A share of the after-tax profit of a company, distributed to its shareholders according to the number of shares held by them.

Smaller companies typically distribute dividends at the end of an accounting year (final dividend), whereas larger, publicly held companies usually distribute it every quarter (interim dividend).

The amount and timing of the dividend is decided by the board of directors, who also determine whether it is paid out of current earnings or the past earnings kept as reserve.

Dividends provide an incentive to own stock in stable companies even if they are not experiencing much growth.

The companies that offer dividends are most often companies that have progressed beyond the growth phase, and no longer benefit sufficiently by reinvesting their profits, so they usually choose to pay dividend to their shareholders.

Types of dividend policy:

1.Regular dividend policy: in this type of dividend policy the investors get dividend at usual rate. Here the investors are generally retired persons or weaker section of the society who want to get regular income. This type of dividend payment can be maintained only if the company has regular earning.

Merits of Regular dividend policy:

It helps in creating confidence among the shareholders.
It maintaining the market value of shares.
It helps in marinating the goodwill of the company.
It helps in giving regular income to the shareholders.

2. Stable dividend policy: here the payment of certain sum of money is regularly paid to the shareholders. It is of three types:

a) Constant dividend per share: here reserve fund is created to pay fixed amount of dividend in the year when the earning of the company is not enough. It is suitable for the firms having stable earning.

b) Constant pay-out ratio: it means the payment of fixed percentage of earning as dividend every year.

c) Stable rupee dividend + extra dividend: it means the payment of low dividend per share constantly + extra dividend in the year when the company earns high profit.

3.Irregular dividend: as the name suggests here the company does not pay regular dividend to the shareholders. The company uses this practice due to following reasons:

Due to uncertain earning of the company.
Due to lack of liquid resources.
The company sometime afraid of giving regular dividend.
Due to not so much successful business.

4. No dividend: the company may use this type of dividend policy due to requirement of funds for the growth of the company or for the working capital requirement.

Factors Affecting Dividend Policy:

1. Stability of Earnings: The nature of business has an important bearing on the dividend policy. Industrial units having stability of earnings may formulate a more consistent dividend policy than those having an uneven flow of incomes.

2. Age of corporation: Age of the corporation counts much in deciding the dividend policy. A newly established company may require much of its earnings for expansion and plant improvement and may adopt a rigid dividend policy. But, an older company can formulate a clear cut and more consistent policy regarding dividend.

3. Liquidity of Funds: The liquidity of a firm depends very much on the investment and financial decisions of the firm which in turn determines the rate of expansion and the manner of financing. If cash position is weak, stock dividend will be distributed and if cash position is good, company can distribute the cash dividend.

4. Extent of share Distribution: Nature of ownership also affects the dividend decisions. A closely held company is likely to get the assent of the shareholders for the suspension of dividend or for following a conservative dividend policy. On the other hand, a company having a good number of shareholders widely distributed and forming low or medium income group, would face a great difficulty in securing such assent.

5. Needs for Additional Capital: Companies retain a part of their profits for strengthening their financial position. The income may be conserved for meeting the increased requirements of working capital or of future expansion. Thus, such Companies distribute dividend at low rates and retain a big part of profits.

6. Trade Cycles: Business cycles also exercise influence upon dividend Policy. Dividend policy is adjusted according to the business oscillations. During the boom, prudent management creates food reserves for contingencies which follow the inflationary period. Higher rates of dividend can be used as a tool for marketing the securities in an otherwise depressed market.

7. Taxation Policy: High taxation reduces the earnings of the companies and consequently the rate of dividend is lowered down. Dividend-tax of distribution of dividend beyond a certain limit, also affects the dividend policy.

8. Legal Requirements: In deciding on the dividend, the directors take the legal requirements too into consideration. In order to protect the interests of creditors an outsiders, the companies Act prescribes certain guidelines in respect of the distribution and payment of dividend. Moreover, a company is required to provide for depreciation on its fixed and tangible assets before declaring dividend on shares.

9. Past dividend Rates:While formulating the Dividend Policy, the directors must keep in mind the dividend paid in past years. The current rate should be around the average past rate. If it has been abnormally increased the shares will be subjected to speculation. In a new concern, the company should consider the dividend policy of the rival organisation.

10. Ability to Borrow: Well established and large firms have better access to the capital market than the new Companies and may borrow funds from the external sources if there arises any need. Such Companies may have a better dividend pay-out ratio.

11. Policy of Control: Policy of control is another determining factor is so far as dividends are concerned. If the directors want to have control on company, they would not like to add new shareholders and therefore, declare a dividend at low rate.

12. Repayments of Loan:A company having loan indebtedness are vowed to a high rate of retention earnings, unless one other arrangements are made for the redemption of debt on maturity. It will naturally lower down the rate of dividend. Sometimes, the lenders (mostly institutional lenders) put restrictions on the dividend distribution still such time their loan is outstanding.

13. Time for Payment of Dividend: When should the dividend be paid is another consideration. Payment of dividend means outflow of cash. It is, therefore, desirable to distribute dividend at a time when is least needed by the company because there are peak times as well as lean periods of expenditure. Wise management should plan the payment of dividend in such a manner that there is no cash outflow at a time when the undertaking is already in need of urgent finances.

14. Regularity and stability in Dividend Payment: Dividends should be paid regularly because each investor is interested in the regular payment of dividend. The management should, in spite of regular payment of dividend, consider that the rate of dividend should be all the most constant.

Legal aspects of dividend policy, Companies Act 2013:

1.Companies declare or pay dividend for any financial year out of the current year profit or accumulated profit (free reserves only) after providing depreciation.

2. Before declaration of dividend, a company may transfer a portion from the profit to the reserves of the company. The company is free to decide the percentage for such transfer to the reserve.

3. The Board of Directors may declare interim dividend during financial year out of surplus in profit and loss account. In case, a company is incurring loss as per financials of latest quarter, interim dividend shall not be higher than average dividend declared by the company during last three financial years.

4. The amount of dividend and interim dividend shall be deposited in a separate account in a scheduled Bank within five days from the date of declaration of such dividend.

5. Where a dividend has been declared by a company but has not been paid or claimed within thirty days from the date of the declaration to any shareholder entitled to the payment of the dividend, the company shall, within seven days from the date of expiry of the said period of thirty days, transfer the total amount of dividend which remains unpaid or unclaimed to a special account to be opened by the company in that behalf in any scheduled bank to be called the Unpaid Dividend Account.