Dividend Coverage Ratio

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on September 8, 2021

Dividend coverage ratio shows the number of times the dividend is covered by available profit and is calculated separately for each class of shares.

Formula

For preference shares:
dividend-coverage-ratio-formula-preference
and for ordinary (common) shares:
dividend-coverage-ratio-formula-ordinary

Example

Profit before tax: $480,000
Corporation tax rate: 50%
Dividend to preference shareholders: $15,000
Dividend to ordinary shareholders: $25,000
Calculate dividend coverage ratio for the use of both preference shareholders and ordinary (common) share holders.

Solution

For preference shareholders:
Dividend coverage ratio = (480,000 – 240,000)/$15,000
= 16 times
For ordinary (common) shareholders:
Dividend coverage ratio = ($480,000 – $240,000 – $15,000)/$25,000
= 9 times
A high dividend coverage ratio is the indication of the fact that the company will continue to be able to pay similar or higher dividends in future. A low dividend coverage ratio, on the other hand, shows that even a small decrease in company’s profit will result in reduction in the dividend rate – in other words, the dividends may not be safe. Obviously, a high dividend coverage command better price at the stock exchange.

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