Concept of Dividend Policy

Concept of Dividend Policy

Dividend policy is the policy which concerns quantum of profits to be distributed by way of dividend. Dividend refers to the portion of net income paid out to shareholders. It is paid in cash and/or stock for making an investment and bearing risk. Dividend decision of the firm is yet another crucial area of financial management as it affects shareholders wealth and value of the firm. It is a financial decision that refers to the proportion of the firm’s earnings to be paid out to the shareholders

The dividend policy of a company affects the type of arrangement through which shareholders receive the return on their investment and is also an integral decision of a company’s board of directors.  is important because it outlines the magnitude, method, type, and frequency of dividend distributions. The percentage of earnings paid out in the form of the cash dividend is known as the dividend payout ratio. A company may retain some portion of its earnings to finance new investment.

Dividend policy is an integral part of the firm’s financing decision as it provides internal financing. Dividend policy is concerned with determining the proportion of a firm’s earnings to be distributed in the form of cash dividend and the portion of earnings to be retained.

A firm has three alternatives regarding the payment of cash dividends:

  1. It can distribute all of its earnings in the form of cash dividends,
  2. It can retain all of its earnings for reinvestment,
  3. It can distribute a part of earnings as dividend and retain the rest for reinvestment purpose.

When dividends are paid to the stockholders the firm’s cash is reduced. Dividend policy of a company sets the guidelines to be followed while deciding the amount of dividend to be paid out to the shareholders. A firm may decrease its dividend payout and use the retained funds to expand its capacity, to pay off some of its debt or to increase investment. In this way, the firm’s dividend policy is closely related to the firm’s investment and financing decisions.

It should be recognized that a firm’s dividend payout ratio depends on many factors. For example, it may be affected by the volatility in the firm’s cash flows and changing investment needs over time. If the firm’s cash flow is volatile, it may prefer to set a minimum level of regular cash dividends that can be maintained even at low profits.

 

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