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Dividend Decisions

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There are basically two options which a firm has while utilizing its profits after tax. Business Entities have options such as putting back the earnings by retaining them or distribute the same to the shareholders. Dividends are a way for the business to reward its shareholders. This return is normally paid in cash although it can be paid in other forms such as through Bonus shares also known as scrip dividends as we shall see later on. Dividends can be both equity dividends and preference dividends. The latter are fixed in nature and are paid every year as a percentage to the preference shareholders if net earnings are positive. Preference dividends are usually paid first after which, the balance of net profits are distributed or kept within the business or both based on the decisions management takes.

When analyzing a dividend policy we need to understand its effect on a company’s value If the company is able to invest in new opportunities it creates additional value,on the other hand if a business fails to invest in new opportunities the share holders suffer an opportunity loss. The decisions of investing, financing and dividends are often interdependent and require trade offs to arrive at optimum decisions.The dividend decision is not a short run decision that is made once and forgotten it requires planning and will often cross over more than one accounting year.

Determinants of Dividend policy

A company will not distribute all its earnings as dividends; the decision to distribute dividends will be determined by the following factors

Dividend payout ratio:

This represents the percentage of shares of the net earnings that are distributed to the shareholders as dividends. Dividend policy involves taking a decision on whether to payout dividends or retain them so that they can be re invested into the business. It I important to note that retained earnings are a source of finance. For a dividend policy to be successful it must be able to strike a balance between the need to pay current dividends and the future growth of the company as well. When determining the dividend payout ratio we should be mind full of two aspects tone of which is maximizing the shareholders wealth and the other being to have a source of funds to finance further growth.

Stability of dividends:

By this we mean the ability of the business entity to pay a certain minimum figure of dividends in a regular manner. This can imply any of the following 1-Constant dividend per share 2-Constant dividend payout ration 3-fixed dividend per share including an additional dividend.

Legal stipulations do not require a dividend declaration but they specify the conditions under which dividends are to be paid out.These may relate to issues like impairment of capital,net profits and insolvency.Important contractual restrictions may be accepted by the company regarding payment of dividends when the Company obtains external funds.Theses restrictions may cause the firm to restrict the payment of cash dividends until a certain level of earnings has been achieved or limit the amount of dividends paid to a certain amount of earnings.Different business firms may have differing Internal constraints and include assets that are liquid in nature,their growth prospects,financial needs,availability of funds,earnings stability and control.

Owners considerations:

If the owners consider the tax status of the shareholders as well as their opportunities for investment and dilution of ownership this may cause a change in the dividend policy.

Capital market considerations:

The extent to which the firm has access to the capital markets,may affect the dividend policy.Where the firm has relatively easy access to the capital markets,it most likely will adopt a liberal dividend policy.For firms with only limited access to capital markets,they are likely to adopt a low dividend pay out ratio.For such companies much of their financing comes from the use of retained earnings.

Inflation:

Inflation is a situation where there is a general price increase in the items of everyday use.In the business sense these may be things like machinery and equipment.Sometimes depreciation produces enough funds to replace obsolete equipment,however,during inflation these funds may not be sufficient enough to replace obsolete items hence impacting on the dividend pay out ratio negatively.

Factors that may influence the Dividend Decision

Investment opportunities: Businesses with good investment opportunities might try to minimize dividend payments and retain the profits to be used in investment financing.

Financing opportunities:

In some cases,raising external finance might be a challenging matter,in such cases,the company will rely on retained earnings other than paying dividends. Legal commitments might impose restrictions on how much a company can distribute as dividends: Loan commitments might include some covenants restricting payments during the loan period.

Profit stability will determine if a company is able to pay a stable dividend over time.:

Control desired by share holders:

If the share holders want control to be restricted amongst the few members they will use retained earnings to avoid having to issue more shares.

Investors Expectations:

Investors expectations about the level of dividends to be paid might actually influence the actual dividend.

Dividend policy of similar companies:

The dividend policy of other similar businesses since investors make comparisons amongst businesses.

Alternatives to Cash Dividends

Sometimes Dividends may not be paid out in cash form,it is important for you as a business owner or shareholder to know what form dividends may be paid out other than cash form.

Bonus share

This is referred to as a stock dividend.it involves payment to existing owners of dividends in the form of shares,the shareholders do not pay for these shares.It is an integral part of dividend policy of a firm to use bonus shares and stock splits.

A Stock split

Is a method commonly used to lower the market price of shares by increasing the number of shares belonging to each share holder.Bonus shares may be issued to satisfy the existing shareholders in a situation where cash position has to be maintained.

Share Repurchases

A program by which a company buys back its own shares from the market place,reducing the number of outstanding shares.Getting back shares by repurchasing them may be a sign that the company thinks its Shares are undervalued. The company can buy shares straight from the market or offer its share holder the option to tender their shares directly to the company at a fixed price.

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