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 valuePar ValuePar value of shares is the minimum share value determined by the company issuing such shares to the public. Companies will not sell such shares to the public for less than the decided 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 dividendDividendDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company. 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 statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. 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 dividendsPreferred DividendsPreferred dividends refer to the amount of dividends payable on preferred stock from profits earned by the company, and preferred stockholders have priority in receiving such dividends over common stockholders. 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 companyProfitability Of The CompanyProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance. 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 –