If your business is publicly-listed, you’ll need to consider whether to issue dividends to your shareholders, if you haven’t already done so. There are a broad range of dividend policy models, and for many businesses, settling on a specific dividend policy can be a challenge. Find out everything you need to know about the four main dividend policy types with our simple guide. First up, what is a dividend policy?
What is a dividend policy?
Before we investigate dividend policies, let’s explore the concept of the “dividend” itself. Essentially, a dividend is money that publicly-listed companies pay out to shareholders. To put it a different way, dividends are the way that businesses distribute their profits. Deciding if and when to issue dividends is an important moment for many businesses, so it’s important for company owners to have a solid understanding of the range of dividend policy models before making a decision.
So, what is a dividend policy? Simple. A dividend policy is the strategy that businesses use to structure these types of payments. It determines the frequency with which dividends are paid out, as well as the amount of the payment. There are several different factors that may determine the dividend policy type favored by a business, including debt obligations, earnings stability, shareholder expectations, the company’s financial policy, and the impact of the trade cycle.
So, how many different types of dividend policy are there? There are four main dividend policy types: regular dividend policy, stable dividend policy, irregular dividend policy, and no dividend policy. Let’s explore these in a little more detail:
Regular dividend policy
Under a regular dividend policy, companies pay out dividends to shareholders every year. If a company makes more profit than it was expecting, the excess profits will be held by the company as retained earnings, instead of being distributed to shareholders. However, if the company makes a loss, shareholders will still be paid a dividend. Generally, a regular dividend policy is best suited to a company with a steady cash flow and good liquidity.
Stable dividend policy
Companies with a stable dividend policy provide a fixed dividend payment every year, even when earnings are volatile. For example, if a payout rate of 8% is set, then that’s the percentage of profits that the company will pay out, regardless of its performance during the financial year. It’s worth noting that you’ll receive the same fixed percentage, whether the company earned $1,000,000 or $100,000. Since the amount of your dividend fluctuates, depending on the level of profit, businesses with a stable dividend policy may be a risky investment.
Irregular dividend policy
With an irregular dividend policy, there’s essentially no set schedule for issuing dividends, which means that the company’s board of directors will decide what to do with the firm’s profits. If your business experiences an abnormally profitable quarter, for example, they can either decide to issue dividends or retain the profits and invest them back into the business. Generally speaking, irregular dividend policies are a good fit for companies that don’t have a stable cash flow.
No dividend policy
Finally, there’s the option of not distributing dividends at all. Within this dividend policy model, all profit is retained and reinvested into the business to fund growth opportunities. Generally, companies without a dividend policy tend to grow and expand at a rapid rate, and the value of their company stock is likely to appreciate significantly. This can be especially attractive to investors, as the value of shares is more important than the value of any potential dividends that they may be missing out on.
Choosing the right dividend policy for your business
When you’re making our dividend policy decision, you should pay attention to the determining factors mentioned earlier in the article. What are your business’s future investment needs? How significant are your company’s debt obligations? Can you issue dividends while retaining an adequate level of working capital? All these questions need to be answered before making a dividend policy decision.
Another important element to focus on is your business’s cash flow. A strong, steady cash flow may be well suited to a regular dividend policy. However, if your business has a more irregular cash flow then committing to regular dividend payments may not be the best idea. In this case, an irregular dividend policy or no dividend policy at all may be the right option for your company.
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