What is Cumulative Preferred Stock?
Cumulative preferred stock are those class of shares wherein any unpaid or undeclared dividends for the current year must be accumulated and paid for in the future. However, such stocks are costlier, do not have voting rights and cannot demand the interim dividends.
Cumulative Preferred stockholders get a fixed dividend rate irrespective of the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. ; this means they are not participating in the profits of the company. The benefit of these stocks is that in case of the financial crisis if the company will not be able to declare the dividend then also the dividend amount will get accumulated and will get paid in the future whenever the company declares the dividendDeclares The DividendDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities..
The company has not declared dividends in the last 4 years due to the financial crisisFinancial CrisisThe term "financial crisis" refers to a situation in which the market's key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.. For the last 4 years, the dividends for the cumulative preferred stockholders were $20 each year that was unpaid.
The business in the 5th year was great, and therefore, the management declares a dividend to its shareholders. However, the company will have to pay $80 to the cumulative preferred stockholders first and then they are allowed to distribute the dividends to the common shareholders.
- The cumulative preferred stocks are safe and secure when it comes to financial safety among all other stocks available in the market. The reason behind the same is that they will always get their dividend irrespective of the bad performance of the company.
- These stockholders are privileged to get the dividends before any other stockholder of the company.
- In an unpleasant situation of liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order. of the company, the cumulative preferred stockholders get the settlement at the earliest in comparison to other stockholders.
- The company has an obligation to give the cumulative preferred stockholder the right to demand the dividend in case of any financial failure. If at that time, the dividends are not paid, then the dividends are accumulated in accounts and are paid afterwards to the cumulative preferred stockholders when things are normal for the company.
- Such stockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares. may get a higher rate of return in case the company gets a profitable year.
- The biggest disadvantage is that they don’t enjoy voting rights compared to other stockholders.
- Such shareholders will always get the fixed dividend irrespective of the profit earned during the year. In contrast, other stockholders will get the dividend payment as per the profits earned by the company.
- It is costly than any other stocks available in the market since the cumulative preferred stock carries some extra privileges.
- They may get partial or delayed dividend payments from the company.
- The dividends are fixed, but in case of any other stocks like debts the management will have to pay the debt interest to the holder as well, and there cannot be any delay in the payment of the same.
- These stockholders cannot claim dividend in the middle of the year. They are not allowed interim dividends they are only paid yearly.
This has been a guide to what is cumulative preferred stock. Here we discuss how it works along with examples, advantages and disadvantages. You can learn more about financing from the following articles –