Question

Since dividend payment is a mechanism that provides the health condition of a corporation, management needs to provide meaningful and comprehensive tools to decide how the dividends should be paid. Do you see any principle affecting the dividend policy?

Answer 1

Principle affecting the dividend policy:-

1. Maintenance of Reserves: Various reserves for different pur­poses are needed for efficient running of a company. Reserves for — depreciation, working capital, bad debts, dividend equalization, expansion, taxation, debenture redemption, and preference share redemption are very common for a company to keep apart. The surplus is available for dividend.

2. Existence of Earned Surplus: A company cannot pay divi­dends out of capital. Dividend is payable out of current profits or accumulated profits of a company. It can be paid after pro­viding for depreciations as per Companies Act.

3. Cash Needs of a Company:Cash position is a big criterion to pay dividend. For a company, cash is needed for various con­tingencies. They cannot be ignored for the survival of a com­pany. So, dividend policy has to be made after a serious consid­eration of the cash position of the company.

4. Need for Growth and Expansion: Company nees cash for growth and expansion and if any excess cash is there in the books of the company, it can pay as dividend to shareholders.

5. Steady and Stable Dividend Policy: An ideal dividend policy rests on the principle of stability and steadiness. Attractive div­idend rate — after providing for reasonable, regular and stable income — should be aimed at.

6. Government Taxation Policy: In these days corporate taxation is a very important factor to take into consideration. Government levies huge amount of taxes on companies to augment its revenue needs. This means the management is put into difficul­ty in maintaining stable or high rate of dividend. So, this has to be considered while formulating dividend policy.

7. Legal Restrictions: There may be ceiling on the rate of divi­dend imposed by the Government.

8. Dividend Restrictions by Creditors: Lenders to companies, while granting long term credit, may restrict the rate of divi­dend payment.

9. Inflation: Inflation may also affect the dividend policy of a firm. With rising prices, funds which are generated by way of depreciation may fall short in order to replace obsolete equipment.