1. Chapter Introduction

2. Dividend out of Profits

3. Dividend Policy Goals

4. Role of Finance Manager

5. Factors Affecting Dividend Decision

1.   Chapter Introduction:

This chapter will acquaint you with the meaning, types and purposes of dividend. Dividend is a portion of the profits distributed to shareholders in a company and is usually expressed as a percentage of nominal value of shares. Dividends are often paid in cash, though in theory other forms also exist.

Dividend affects the mood of the present shareholders, it also influences the behaviour and response of prospective investors, stock exchanges and financial institutions because of its relationship with the worth of the company which in turn affects the market value of its shares. The decision regarding dividend is taken by the Board of Directors and is then recommended to the shareholders for their formal approval in the annual general meeting of the company.

2. Dividend out of Profits:

Q. "Dividend can be paid out of profits". Explain this statement. Will a company be justified in paying dividends when it has unwritten-off accumulated losses of the past? (Dec. 99)

The word dividend is derived from 'dividendum' which means total divisible sum. The expression dividend has two meanings. For an existing company, i.e., going concern, the dividend is the distribution of divisible profits by a joint stock company to its shareholders by way of return on their investments in the shares after complying with the provisions of the Companies Act and Articles of Association of the company. In the case of winding up, it means a division of the realised assets among the creditors and contributors according to their respective rights. The legal provisions as to dividends for a company as a going concern are summarised as under:

1. Dividends cannot be paid except out of profits. As such the payment of dividend is ruled out when there is loss except where the Central or State' Government has guaranteed the payment of dividends by the company (Section 205).
2. Dividend must be paid within 42 days of declaration (Section 207).
3. Dividend is payable only to a registered shareholder or on his order to his banker. However where a company has issued share warrants in pursuance of Section 114, dividend is to be paid to the bearer of such warrantor to his banker.
4. Articles normally provide (as Article 88 of. Table A) that dividends may be paid up in proportion to the amount paid up on each share (Section 93). In the absence .of such provision, dividends are payable on the nominal amount of each share and not on the amount paid. [Oak Bank Oil Company Vs. Crum (1882) & App. Cas. 65 H.L.]
5. No dividend is paid on calls-in-advance; it would be unjust if the same sum paid on shares carried interest and dividend at the same time.
6. Where calls are in arrears, the company can make provision in the articles prohibiting the payment of dividends on shares on which full amount has not been paid. Otherwise dividend is payable only on the amount actually paid up.
7. The amount of dividend payable to shareholders may be rounded off to the nearest rupees. Thus where such amount contains a part of a rupee consisting of paisa, then, if such part is fifty paisa or more, it shall be increased to one rupee and if such part is less than fifty paisa, it shall be ignored. .

Dividends out of current years profits: A company can declare dividend out of current year's profits only after providing for depreciation in accordance with the provisions of sub-section (2) of Section 205.

Dividends out of previous year's profits: A company can pay dividend out of the profits of any financial year(s) which falls after the commencement of Companies (Amendment) Act 1960 after providing for depreciation in accordance with those provisions and remaining undistributed. The legal position is summarised as under: .

(1) Arrears of depreciation are to be considered only if dividend for any financial year is declared out of profits of any previous financial year or years falling after 28 December, 1960. '.

(2) If the company has incurred any loss in any previous financial year or years falling after 28th December, 1960, then

(a) the amount of loss; or

(b) an amount which is equal- to the amount provided for depreciation for that year or those years, whichever is less, shall be set off:

(i) against the profits of the company for the year for which the dividend is proposed to be declared or paid; or

(ii) against the profits of the company for any previous financial year or years arrived at after providing for the prescribed depreciation as per Section 205 (2); or .

(iii) against the aggregate of (i) and (ii) together.

(3) The Central Government may, if it thinks necessary to do so in the public interest, allow any company to declare or pay dividend for any financial year out of the profits of the company for that year or years or any financial year without providing for depreciation.

(4) It shall not be necessary for the company to provide for arrears of depreciation where dividend for any financial year is declared or paid out of profits of any previous financial year or years which falls or fall before 28 December, 1960.

(5) Dividends can be declared out of the aggregate of the profits of the current year and previous year(s).

Dividend out of subsidy: Where the Central or State Government has guaranteed the payment of dividend by the company, dividend may be paid out of money provided by such Government.

DIVIDENDS OUT OF RESERVES

In case of inadequacy or absence of profits in any year, a company can declare and pay dividends by withdrawing amount out of reserves. It is clear that only revenue reserves, which are free and uncommitted, can be used for this purpose. Section 205 A (3) inserted by Companies (Amendment) Act, 1974, provides that declaration of dividends out of the accumulated profits earned by the company in previous years and transferred by it to the reserves cannot be made in case of inadequacy or absence of profits in any year, except in accordance with the prescribed rules or in special cases with the previous approval of the Central Government. The prescribed rules framed by the Central Government in this respect are known as the Companies (Declaration of Dividend out of Reserves) Rules, 1975. Rule 2 provides that in the event of inadequacy or in the absence of profits in any year, dividend may be declared by a company for that year out of the accumulated profits earned by it in the previous year and transferred by it to the reserves, subject to the conditions that:

1. The rate of dividend shall not exceed the average of the rates at which dividend was declared by it in the five years immediately preceding that year or 10 per cent of its paid up capital, whichever is less;
2. The total amount to be drawn from the accumulated profits earned in previous years and transferred to the reserves shall not exceed an amount equal to one tenth of the sum of its paid up capital and free reserves and the amount so drawn shall first be utilised to set off the losses in the financial year before any dividend in respect of preference or equity shares is declared; and
3. The balance of reserves after such draw shall not fall below 15 per cent of its paid up capital. Explanation: For the purpose of the rules, profit earned by a company in previous years and transferred by it to the 'reserves' shall mean the total amount of net profits after tax, transferred to reserves as at the beginning of the year for which the dividend is to be declared; and in computing the said amount, the appropriations out of the amount transferred from the Development Rebate Reserve (at the expiry of the period specified under the Income Tax Act, 1961) shall be included and all items of capital reserves including reserves created by revaluation of assets shall be excluded.

3. Dividend Policy Goals:

Q. "While formulating a dividend policy, the management has to reconcile company's need for funds with the expectations of the shareholders." Elaborate this statement and state the policy goals which have to be kept in view by the management while taking a decision on dividends. (Dec. 02)

The objective of corporate management is to maximize the market value of the enterprise. The market value of common stock of a company is influenced by its policy regarding allocation of net earnings into "plough back" & "payout". While maximizing the market value of shares, the dividend policy should be so oriented as to satisfy the interests of the existing shareholders as well as to attract the potential investors. Thus, the aim should be to maximize the present value of future dividends and the appreciation in the market price of shares.

Dividend Policy Goals

• Dividend policy should be analyzed in terms of its effect on the value of the company.
• Investment by the company in new profitable opportunities creates value and when a company foregoes an attractive investment, shareholders incur an opportunity loss.
• Dividend, investment, & financing decisions are interdependent and there is often a trade off.
• Dividend decision should not be considered as a short run residual decision.
• Whatever dividend policy is adopted by the company, the general principles guiding the dividend policy should be communicated clearly to investors.
• Erratic & frequent changes in dividends should be avoided. Reduction in the rate of dividend is painful thing for the shareholders to bear.

4. Role of Finance Manager:

Q. Discuss the role of the financial manager in the matter of dividend policy. What alternative might he consider and what factors should he take into consideration before finalizing his views on dividend policy. (June 00)

The disposal of the earnings is an issue of fundamental importance in financial management. The financial manager plays a key role in advising the management, i.e., Board of Directors regarding the decision. It is the latter whose privilege it is to take the decision. The retention of profits in business helps the company in mobilizing funds for expansion.

The dividend policy, particularly the timing of the declaration of dividend, influences the market value of a company's shares. The financial manager, therefore, should be well informed about the capital market trends and the tax policies of the government, besides the rationale behind the investment programme of the company.

The dividend alternatives available to finance manager while deciding the dividend decision are listed below:

• Regular Dividend: If the company gives dividend every year right from the initial year of operation, it is called regular dividend.
• Stable Dividend: Whether equal amount or a fixed % of dividend paid every year, irrespective of the quantum of earnings as in case of preference shares, i.e., stable dividend.
• Fixed Payout Ratio: When a fix payout ratio is decided on the total of earning available is called fixed payout ratio.
• Bonus Shares or Property Dividend: In this case, the company issues bonus shares.