Factor Affecting Dividend Policy

8/13/2019 Factor Affecting Dividend Policy

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FACTOR THAT AFFECT THE

DIVIDEND DECISION OF THE FIRM

Presented byAjay Kamble

Krutika Sawant

Rajiv MauryaVinod kumar

Parminder


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INTRODUCTION

What is dividend

What is Dividend policy

Factors affecting Dividend Policy


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What is dividend

A dividend is a distribution to shareholders out

of profit or reserve available for this purpose.

Institute of Chartered Accountants of India


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What is Dividend Policy

Dividend policy involves the decision to pay out

earnings or to retain them for reinvestment in

the firm. The retained earnings constitute a

source of financing . The payment of dividendsresults in the reduction of cash and, therefore, in

a depletion of total assets.


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Regularity and stability in Dividend Payment. Dividends should bepaid regularly because each investor is interested in the regularpayment of dividend. The management should, inspite of regularpayment of dividend, consider that the rate of dividend should be allthe most constant. For this purpose sometimes companies maintain

dividend equalization Fund.

Age of corporation.Age of the corporation counts much indeciding the dividend policy. A newly established company mayrequire much of its earnings for expansion and plant improvementand may adopt a rigid dividend policy while, on the other hand, an

older company can formulate a clear cut and more consistent policyregarding dividend.


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Liquidity of Funds.Availability of cash and sound financial positionis also an important factor in dividend decisions. A dividendrepresents a cash outflow, the greater the funds and the liquidity ofthe firm the better the ability to pay dividend. The liquidity of a firmdepends very much on the investment and financial decisions of thefirm which in turn determines the rate of expansion and the mannerof financing. If cash position is weak, stock dividend will bedistributed and if cash position is good, company can distribute thecash dividend.

Taxation Policy.High taxation reduces the earnings of hecompanies and consequently the rate of dividend is lowered down.Sometimes government levies dividend-tax of distribution ofdividend beyond a certain limit. It also affects the capital formation.N India, dividends beyond 10 % of paid-up capital are subject todividend tax at 7.5 %.


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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 1956 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. It

proposes that Dividend should not be distributed out of

capita, in any case. Likewise, contractual obligation shouldalso be fulfilled, for example, payment of dividend on

preference shares in priority over ordinary dividend.


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Net Profit :- in that it restricts the dividend to be paid out ofthe firms current profits plus past accumulated retainedearnings. Alternatively, a firm cannot pay cash dividendsgreater than the amount of current profits plus the

accumulated balance of retained earnings. Fro instance,section 205 of the Indian companies act provides thatdividends shall be paid only out of the current companycan count on the profits of previous year. If the currentyears profits fall short of the required funds formaintaining a desired stable dividend policy. Likewise ifthere are past accumulated losses, they should be firstset off against current earnings before the payment ofdividend.


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insolvency:- A firm is said to be insolvent in twosituations; first , when its liabilities exceed the assets;and second when it is unable to pay its bills. If the firms is

currently insolvent in either sense, it is prohibited formpaying dividends. Similarly, a firm would not paydividends if such a payment leads to insolvency of eithertype. The rationale of the rule is to protect the creditorsby prohibiting the liquidation of near-bankrupt firms

through cash dividend payments to the equity owners.


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Time for Payment of Dividend. When should the dividend

be paid is another consideration. Payment of dividendmeans outflow of cash. It is, therefore, desirable to distributedividend at a time when is least needed by the companybecause there are peak times as well as lean periods ofexpenditure. Wise management should plan the payment ofdividend in such a manner that there is no cash outflow at atime when the undertaking is already in need of urgentfinances.


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Past dividend Rates.While formulating the Dividend Policy, thedirectors must keep in mind the dividend paid in past years. The

current rate should be around the average past rat. If it has beenabnormally increased the shares will be subjected to speculation.In a new concern, the company should consider the dividendpolicy of the rival organization.

Government Policies. The earnings capacity of the enterprise iswidely affected by the change in fiscal, industrial, labour, controland other government policies. Sometimes government restrictsthe distribution of dividend beyond a certain percentage in aparticular industry or in all spheres of business activity as was done

in emergency. The dividend policy has to be modified orformulated accordingly in those enterprises.


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Policy of Control.Policy of control is another determiningfactor is so far as dividends are concerned. If the directorswant to have control on company, they would not like to addnew shareholders and therefore, declare a dividend at low

rate. Because by adding new shareholders they fear dilution ofcontrol and diversion of policies and programmes of theexisting management. So they prefer to meet the needsthrough retained earring. If the directors do not bother aboutthe control of affairs they will follow a liberal dividend policy.

Thus control is an influencing factor in framing the dividendpolicy.


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Repayments of Loan.A company having loanindebtedness are vowed to a high rate of retentionearnings, unless one other arrangements are madefor the redemption of debt on maturity. It will

naturally lower down the rate of dividend.Sometimes, the lenders (mostly institutionallenders) put restrictions on the dividend distributionstill such time their loan is outstanding. Formal loancontracts generally provide a certain standard of

liquidity and solvency to be maintained.Management is bound to hour such restrictions andto limit the rate of dividend payout.


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Needs for Additional Capital. Companiesretain apart of their profits for strengthening their financialposition. The income may be conserved for meetingthe increased requirements of working capital or of

future expansion. Small companies usually finddifficulties in raising finance for their needs ofincreased working capital for expansionprogrammes. They having no other alternative, usetheir ploughed back profits. Thus, such Companies

distribute dividend at low rates and retain a big partof profits.


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Thank you

Factor Affecting Dividend Policy

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