What is Cumulative Dividend?
Cumulative Dividend is the promise of paying a fixed percentage of earning to the preferred shareholders. If due to any reason the company is unable to pay the dividend within the pre-decided date, then the dividend gets accumulated and is paid in the future.
- Preferred Dividend Rate = The rate that is fixed by the company while issuing the shares.
- Preferred share Par Value = Preferred shares come with a par value, that is the Face value of the share.
- The dividend payment amount is fixed. It doesn’t depend on the profit of the company. The pay-out is fixed irrespective of the particular year’s profitability.
- Unlike other shares, where the dividend is paid in case the company makes a profit, cumulative preferred shares are paid even if the company doesn’t make a profit in a particular year. The fixed dividend is recorded in the financial statements as payable and paid when the company makes a profit.
- Preferred shares receive the distribution of profit before common shareholders. So whatever earning of a company is left after this dividend, is received by common shareholders.
How Does it Work?
The dividends that are supposed to be paid to the preferred shareholders get accumulated if the company doesn’t earn sufficient profit to pay them. Whenever the company earns a profit, then they will have to clear the past accumulated dividends first, then common shareholders can be paid. Preferred dividends are paid before common dividends but after interest on the debt.
Example of Cumulative Dividend
Let’s take an example.
Company XYZ has issued 8% Cumulative Preferred shares with a Par value of $1,000 in the year 2016. Each year company has paid regular annual dividends. In 2018 and 2019, the company didn’t earn any profit and made a loss. Calculate the cumulative dividend that the company will have to pay to the preferred shareholders.
Total Accumulated Dividend is 180, in 2020 if the company makes a profit, then they will have to clear the total accumulation of 180 + 2020 preferred dividend, then common stockholders can be paid.
In 2018, the dividend will be
Dividend To be Paid = 8% * 1000 = 80
In 2019, cumulative dividend wil be –
Dividend To be Paid = 8% * 1000 = 80
Total Accumulated Dividend (2018 + 2019) will be –
Total Accumulated Dividend (2018 + 2019) = 80+ 80 =160
Reasons to Consider for Cumulative Dividend
- Cumulative preferred shareholders know that they will receive dividends irrespective of the profitability of the company for a particular year. So this gives confidence to the shareholders.
- As cumulative preferred shares are safe, so the company can issue them at a lower dividend rate. This reduces the cost of the company.
- Shareholders know that they will receive dividends irrespective of the profitability of the company. So shareholders feel confident about the offering and participate in the issue.
- This is a cost-effective way for companies to raise capital. Unlike debentures where the interest will have to be paid irrespective of the company incurring a loss, but in this dividend, the companies get time for the payment, as the payment gets deferred until the company earns a profit.
- There is no maturity for cumulative preferred shares, so the company will not have to worry about repayment of principal like debt.
- Shareholders often receive interest on this dividend, so they don’t lose money.
- As cumulative dividend comes before a common dividend, so preferred shareholders are safe.
This has been a guide to what is Cumulative Dividend and its definition. Here we discuss its formula and calculations along with an example, features, and advantages. You may learn more from financing from the following articles –