What Is Dividend Policy

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on August 28, 2021

Meanings of Dividend

Dividend is the payment to shareholders in lieu of their share capital. It is that portion of profits of a Company which is distributable among its shareholders according to the resolution passed in the meeting of Directors. This may be a fix percentage on the share capital or at fixed per share. The economic soundness of a company is judged by the amount of dividend declared and paid by the company. It affects shareholders and the goodwill of the firm.

Definition and Explanation of Dividend Policy

Dividend is a part of profit distributed among shareholders. The question before the Board of Directors is how much to distribute and how much to retain in business as resource to meet future contingencies and expansion. Allocation of profit between shareholder and retained earnings is an essential part of management function.
Thus dividend policy implies a recognition to a suitable dividend pattern to its shareholders through its Board of Directors. Dividend Policy is decision-making and problem-solving system. Dividend policy has far-reaching consequences on the share price, growth rate, market price of the share and goodwill of the company. Higher market price of shares and higher current dividends increase the wealth of shareholders.

Factors Influencing Dividend Policy

There are many points which influence the dividend policy of a company are as:
(i) Legal Restriction. There are certain legal restrictions:
(a) Dividend can only be paid out of profit and not out of capital.
(b) The Company can declare and pay dividend out of past years profit.
(c) At least 10% of profit must be transferred to Reserves.
(d) Dividend is payable in cash of course, by following the legal formalities dividend can be paid in Bonus Shares.
(ii) Size of the earnings. Dividend Policy is dependent upon the earnings of the firm. It is not only the amount of dividend but the nature of the earnings bears upon the dividend policy, stable dividend policy is better.
(iii) Shareholders preference. Management should follow that policy which may suit to shareholder’s interest and the company’s interest.
(iv) Liquid Position. The dividend policy must take into account the liquidity position of the company. The payment of dividend reduces cash reserves of the company. A growing company has a pressing needs for funds, in such a situation, the company should not pay dividend in cash.
(v) Management Attitude. This factor is also responsible for dividend policy. Some company uses its own internal sources for financing expansion programmes, if these do so by issuing new shares the control of the company may go in somebody’s hands. When debentures are issued for financing expansion then the risk of fluctuating earning to the existing members.
(vi) Condition of Capital Market. When capital market is comfortable the company follow liberal dividend policy.
(vii) Stability of Earnings. When a company is making remarkable progress. in such case company can follow liberal dividend policy.
(vii) Trade Cycle. When there is inflation in the country in such state of affair the company will earn more profit thus, the company can distribute more dividend, at time of need funds can be borrowed from outside at lesser interest rate.
(viii) Ability to borrow. A company who is able to borrow from external resources at a cheaper rate can borrow from outside in such case the cost of borrowed capital and retained earnings be compared.
(ix) Past Dividend Rate. While deciding the dividend policy previous years rate of dividend is kept in mind.

Different Types of Dividend

1. Cash Dividend

(i) Regular Dividend. It is annually paid proposed b} Board of Directors and approved by shareholder in general meeting.
(ii) Interim Dividend. If Articles of Association so provides the Directors may decide to pay a dividend any time between the two A.G.M. before finalizing A/C. It is generally when Company has huge profits.

2. Stock Dividend

When Company does not have sufficient cash it may pay dividend in Bonus Shares.

3. Script Dividend

It is used when earnings. Justify a dividend, but the cash position of the Company is temporarily weak. So shareholders are issued Shares and Debenture of other Company held by the Company as investments such payment of dividend is known as script dividend.

4. Bond Dividend

In rare instance dividend are paid in the form of Debentures/Bonds or Notes for a long-term period being a fixed rate of interest. The effect is same as of script dividend. The Shareholders becomes the secured creditors.

5. Property Dividend

Same time Dividend is paid in the form of assets instead of earnings. It is when some assets are no longer required in Business.

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