Financial Management

Factors Governing the Dividend Decision

Dividend Decision

The dividend decision is one of the most important financing decisions of the company. A company should have either a policy on the distribution of profits (Reserve) among the investor or a policy on retaining the profits (reserve).

The potential investors of the company are more interested to know the implications of investing in the company.

The company should have to decide between making payments to shareholders and retaining the funds for the future.

The factors affecting the dividend decision are the following:

Earnings: – The Company distribute the dividend among the shareholders out of the present and reserved profits. Therefore, a more significant amount of the profits will ensure a more significant dividend.

Stability Earnings: – Stable earning of the company affecting the dividend decision of the company. Suppose a company having stable earning is in the position to declare more dividends during the period. If a company has low earnings during a period, it will not declare a dividend.

Growth opportunity: – If the company have more opportunity for growth and expansion, then the company will require more finance. In such a case, the company should retain a large part of the earnings, and a small part of it should be paid out as a dividend to the company’s investors.

Cash flow position:-The cash flow position of the company affects the dividend decision of the company. More payments of the dividend to the investors results in outflows of cash. The company may have enough income, but on the other, it will be equally possible that a company may not have sufficient cash to pay the dividend.

So in such a way, the cash flow position affects the dividend decision. If the company have a better cash flow position, the better will be the capacity of the business to pay out the dividend and vice-versa.

Shareholders preference: – The shareholders’ preference also affects the dividend decision of the company. There are two kinds of shareholders-

(1) those shareholders who invest in the company to get regular income

(2) those shareholders who invest in the company to gain capital profits. If the majority of the shareholders are investing in the company to get regular income, then in such a case, the company should declare dividends according to their expectations.

On the other hand, if the majority of the latter type shareholders, the company enjoys freedom about declaring the dividend.

Taxation policy: – Dividend decision of the company depends on the taxation policy of the government. If the tax rate is higher on the dividend, the company should pay less and vice-versa.

But nowadays, dividend income is tax-free in the hands of shareholders. So that shareholder likes to get the higher dividend.

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