IRMS (Indian Railway Management Service) Commerce: Questions 1 of 302

Describe in Detail Subjective▾

Explain briefly the factors that determines the Dividend policy of the company.

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Explanation

Dividend Policy of the Company

To distribute a reasonable amount as dividends to its member and retain the rest for its growth survival and diversification, as such there is no universally accepted dividend policy. It depends upon one firm to another and it varies from time to time because the dividend decisions are taken considering some important factors which in turn determines the dividend policy of a firm.

Factors Determining Dividend Policy

  • Legal Restrictions
  • Magnitude and Trend of Earnings
  • Nature of Shareholders
  • Nature of Industry
  • Position of Profits
  • Liquidity of Funds
  • Age of the Company concern
  • Government Policy
  • Taxation Policy
  • Economic Fluctuations
  • Public Opinion
  • Liquid Resources
  • Other Factors

Explanation

Legal Restrictions

  • Legal provisions relating to dividends as laid down in Section 123 - 127 of Companies Act of 2013, are significant because they lay down a framework within which dividend policy is formulated.
  • The provisions are related to declaration and payment of dividend.
  • As per Companies (Declaration and Payment of Dividend) Rules, 2014, the rate of dividend declared shall not exceed the average of the rates at which dividend was declared by it in the three years immediately preceding that year.
  • These provisions require that the dividend can be paid only out of current profits or undistributed or accumulated past profits after providing for depreciation
  • Companies Act provide that it is legal to pay a dividend only if the capital is not reduced post payment.

Magnitude and Trends of Earnings

The past dividends rate should be kept in mind and be taken as base while declaring the current year dividend.

Nature of Shareholders

  • Investors who utilises dividend as a daily source of income for day to day living should be paid regular dividends.
  • A wealthy investor in a high income tax bracket are generally interested in lower current dividends and high capital gains.
  • The firm must aim at a dividend policy which has a beneficial effect on the wealth of the majority of the shareholders.

Nature of Industry

  • Industry with a steady demand of their products can follow a higher dividend pay-out ratio
  • Cyclic industries should follow a lower pay-out ratio.

Position of Profits

The companies having steady amount of profits can declare higher rate of dividend as compare to companies having fluctuating profits.

Liquidity of Funds

If at the time of declaration of dividend the adequate cash is available then it would be better to pay cash dividends.

Age of the Company

  • A newly established firm should declare less dividend and thus invest major portion of earnings in developmental works.
  • The old companies may adopt liberal dividend policy.

Government Policy

  • The industrial, labour and tariff polices of the Government keeps on changing from time to time which affects the profit of the company ultimately effecting dividend policy.
  • For example – Recently the Government of India slashed the corporate tax to 22% from 30% for all domestic companies without tax exemptions will have a positive effect on profits and dividends.

Taxation Policy

  • Government generally gives tax benefits to the companies which plough back their profits.
  • Government imposes additional taxes on companies having higher D/P ratio so as to encourage ploughing back of profits.

Economic Fluctuations

  • During Recession the amount of profits goes down which leads to reduction of amount of dividends by the company
  • During the time of Boom the companies generally increases the rate of dividend due to higher amount of profit.

Public Opinions

The companies having higher D/P ratio may face criticism of public as the prices of the products generally goes up to declare higher rate of dividends.

Liquid Resources

If the company does not have liquid resources, it is better to declare stock-dividend i.e.. issue of bonus share to its existing shareholders.

Other Factors

  • Future Financial Requirements
  • Inflation
  • Control Objectives
  • Stability of Dividends
  • Requirement of Institutional Investors
  • Government Economic Policy
  • Structure of Ownership
  • Reach and access to Capital Market
  • Managerial Views

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