Question

Explain the factors affecting the dividend policy of a company.

Answer 1

Factors Affecting Dividend Decision:

The finance manager analyses following factors before dividing the net earnings between dividend and retained earnings:

1. Earning:

Dividends are paid out of current and previous year’s earnings. If there are more earnings then company declares high rate of dividend whereas during low earning period the rate of dividend is also low.

2. Stability of Earnings:

Companies having stable or smooth earnings prefer to give high rate of dividend whereas companies with unstable earnings prefer to give low rate of earnings.

3. Cash Flow Position:

Paying dividend means outflow of cash. Companies declare high rate of dividend only when they have surplus cash. In situation of shortage of cash companies declare no or very low dividend.

4. Growth Opportunities:

If a company has a number of investment plans then it should reinvest the earnings of the company. As to invest in investment projects, company has two options: one to raise additional capital or invest its retained earnings. The retained earnings are cheaper source as they do not involve floatation cost and any legal formalities.

5. Stability of Dividend:

Some companies follow a stable dividend policy as it has better impact on shareholder and improves the reputation of company in the share market. The stable dividend policy satisfies the investor. Even big companies and financial institutions prefer to invest in a company with regular and stable dividend policy.