A dividend is a financial term often used in corporates and share markets. The dividend is paid to the shareholders of the company in proportion to their equity holdings. It’s part of the company’s annual profit that gets distributed among the shareholders according to the resolution passed in the meeting of the board of directors. The company can decide on dividends as a fixed percentage of share capital or a fixed amount per share.
Investors and entities involved in investing and the share market consider dividend value to judge the financial soundness and goodwill of the company. Many factors affect the company’s dividend policy required to offer yearly dividends to the shareholder.
This post will discover some key factors affecting the dividend amount or policy.
1. Company Reserves
A company maintains several types of reserves to keep its business operations functional without running short of necessary funds. Many types of reserves, like working capital, dividend equalization, taxation, expansion, and debenture redemption, are maintained for catering to different financial purposes. After allocating a significant portion of earned profit into various company reserves, the balance amount is distributed among shareholders.
2. Cash Requirements
Another key factor affecting a company’s dividend policy is the cash needs of an organization. A firm requires cash for various contingencies because they are vital to its survival. The board of directors analyzes the cash requirements while deciding the current year’s dividend percentage or the fixed amount per share.
3. Growth & Expansion Needs
A company tends to grow and expand to remain competitive in dynamic market conditions, which require huge financial support to invest in various resources and assets. The company must retain some portion of available profits to invest in future opportunities and fuel growth and expansion strategies. Many companies in the stock market pay larger dividends to shareholders and use retained earnings to source the company’s expansion and growth ambitions.
4. Creditors Restrictions
Financing companies, banking institutions, and lenders from unorganized sectors may set a ceiling rate of dividend payment while offering loans to companies. It makes management difficult to set dividend amounts even if they have enough funds from balance profit.
5. Stable Dividend Policy
A stable and steady dividend policy is essential for every company willing to maintain its goodwill and financial health. The company should focus on offering reasonable, constant, and stable dividends to shareholders so investors stay interested and invested. Uncertain dividend policy can cause dissatisfaction among investors and force them to withdraw their money. Therefore, the company must ensure it offers a regular and steady income to shareholders by maintaining dividend equalization and adequate free reserves.
6. Tax Implications
Every country has a different taxation policy on dividends provided by the companies; some tax only dividends, while others tax both capital gains and dividends earned on company shares. In some cases, the government also sets increased tax rates, which can create challenges for the board of directors in deciding and maintaining stable dividends.
7. Balance of Earned Surplus
The amount of the dividend is payable only when sufficient funds are available. The company cannot offer dividends from capital because it’s only allowed to pay from current and accumulated profits.
8. Legal Restrictions
The legal restrictions directly impact the company’s dividend policy. Below are conditions that the government sets to influence management’s dividend decisions:
- The dividend need to be paid only out of profits, not from capital.
- Companies are allowed to pay dividends using funds available in the previous year’s gain.
- At least 10% of earned profit must be transferred into the necessary reserves.
- Dividends should be paid in cash but can also be offered in bonus shares or assets.
9. Finance Expansion
Some companies require to raise funds using internal sources because issuing new shares can affect the ownership position. The management can decide to issue debentures where the company must pay a fixed percentage of interest, even in the case of loss or meager profits.
10. Market Conditions
When market conditions are comfortable and supportive for companies to grow in the long term, they use a liberal approach to deciding shareholders’ dividends. In comparison, if management sees the uncertain market condition, they prefer retaining a significant portion of profits for future needs.
Conclusion
Various factors, including taxation, market conditions, expansion needs, size of profits, company reserves, and legal restrictions, influence a company’s dividend policy. Therefore, when deciding yearly dividends on shares, the board of directors should avoid paying dividends in the initial years and transfer those funds into necessary reserves like dividend equalization reserves. They should also minimize unnecessary expenses to maximize percentage profit and only distribute a portion of the profit as company dividends.