Cumulative dividend

From CEOpedia | Management online

A cumulative dividend is a type of dividend payment in which all of the previously unpaid dividends are paid out to shareholders along with the current dividend. This means that if the company has not paid out dividends for a period of time, all of the outstanding dividends will be paid to shareholders in a single lump sum. For example, if a company has not paid out dividends for the last three years, shareholders would receive the current dividend payment plus the three years worth of unpaid dividends in a single payment. This type of dividend payment is often seen as beneficial to long-term investors and shareholders as it can result in a large dividend payment.

Example of Cumulative dividend

Let’s look at a hypothetical example of a company that has been paying dividends for the last five years. The company has declared that it will pay out a cumulative dividend of $1.50 per share for the upcoming year. This means that shareholders will receive the current dividend of $1.50 per share plus the unpaid dividends from the last five years. The total dividend payment in this case will be equal to $7.50 per share.

In summary, a cumulative dividend is a type of dividend payment in which all of the previously unpaid dividends are paid out to shareholders along with the current dividend. This type of dividend payment is often seen as beneficial to long-term investors and shareholders as it can result in a large dividend payment. An example of this type of dividend payment is a company paying a cumulative dividend of $1.50 per share plus the unpaid dividends from the last five years, resulting in a total dividend payment of $7.50 per share.

Formula of Cumulative dividend

The formula for calculating a cumulative dividend is as follows:

Cumulative Dividend = Current Dividend + Previous Unpaid Dividend

This formula can be further broken down as follows:

Cumulative Dividend = Current Dividend + (Previous Dividend x Number of Years Unpaid)

For example, if a company has not paid dividends for the last three years and the current dividend is $1 per share, the cumulative dividend payment would be calculated as follows:

Cumulative Dividend = $1 + ($1 x 3)
Cumulative Dividend = $4

Therefore, the shareholders would receive $4 per share in cumulative dividend payments.

When to use Cumulative dividend

There are a few situations in which a company would choose to pay out a cumulative dividend. These include:

  • When the company wants to reward shareholders for their loyalty: This is often the case when the company has not been able to pay out dividends in a while due to economic hardship or other issues. By offering a cumulative dividend, the company can reward shareholders for their loyalty and patience.
  • When the company wants to retain more cash: If the company is not in a financial position to pay out a large dividend, they may opt to pay out a cumulative dividend instead. This allows the company to retain more cash and invest it in ways that will benefit the company in the long run.
  • When the company wants to make up for a missed payment: If the company missed a dividend payment in the past, they may choose to pay out a cumulative dividend in order to make up for the missed payment. This is often seen as a way of making up for the lost income that shareholders would have received had the dividend been paid on time.

Cumulative dividends can be beneficial for shareholders as they can result in a large dividend payment. However, it is important for investors to understand the risks and rewards associated with cumulative dividends before making an investment decision.

Types of Cumulative dividend

  • Non-cumulative dividend: A non-cumulative dividend is a dividend payment that is not cumulative and is only paid out to shareholders for the current period. This means that shareholders will only receive the dividend for the current period and any unpaid dividends from prior periods will not be paid out.
  • Cumulative Preferred Stock: Cumulative preferred stock is a type of preferred stock that grants shareholders the right to receive all unpaid dividends from prior periods before any dividends are paid out to common stockholders. This means that if the company has not paid out dividends for a period of time, shareholders will receive all of the unpaid dividends before common stockholders receive any dividend payments.
  • Cumulative Convertible Preferred Stock: Cumulative convertible preferred stock is a type of preferred stock that grants shareholders the right to receive all unpaid dividends from prior periods and also gives them the option to convert their shares into common stock at any time. This type of preferred stock is often seen as beneficial to long-term investors as it gives them the potential to benefit from the conversion of their shares into common stock.

Steps of Cumulative dividend

  • Step one: The company must declare a dividend for the current period. This can be either a cash dividend or a stock dividend.
  • Step two: The company then determines the amount of all unpaid dividends that are owed to shareholders. This can be done by calculating the amount of dividends that were declared in the past but not paid out.
  • Step three: The company then adds the current dividend payment to the amount of unpaid dividends and pays out the total amount to shareholders in a single lump sum.
  • Step four: The company records the payment as a dividend expense on its income statement.

Cumulative dividends can be beneficial to long-term investors and shareholders as they can result in a large dividend payment. This type of dividend payment is an attractive option for companies as it allows them to pay out any unpaid dividends without having to worry about making multiple payments. Companies should consider cumulative dividends if they are looking to reward long-term shareholders or incentivize investors.

Advantages of Cumulative dividend

  • Investment Planning: A cumulative dividend allows shareholders to plan their investments more easily as they can predict the amount of dividend payments they will receive in the future. This allows shareholders to plan their investments more effectively.
  • Increased Liquidity: Cumulative dividends provide an increased level of liquidity for investors as they can more easily access the dividends they have accrued. This allows investors to more easily access their cash when they need it.
  • Improved Returns: Cumulative dividends can lead to increased returns on investment as the unpaid dividends will be added to the current dividend payment. This can result in a larger dividend payment and increased returns on investment.

Disadvantages of Cumulative dividend

  • Risk of Default: Cumulative dividends can put shareholders at risk if the company is unable to pay the accumulated dividends. This can result in a loss of capital for the investor and can potentially lead to financial hardship.
  • Increased Tax Liability: A cumulative dividend can lead to an increased tax liability for the shareholder as all of the unpaid dividends will be taxed at the same rate as the current dividend payment. This can result in a higher tax bill for shareholders.
  • Reduced Capital: A cumulative dividend can lead to a reduction in the company's capital as the unpaid dividends must be paid out from the company's reserves. This can lead to a decrease in the company's capital and can potentially lead to financial hardship.

Limitations of Cumulative dividend

There are some drawbacks to using cumulative dividends as well. One such limitation is that the company must have sufficient cash reserves to make the payments. As the company is paying out the cumulative unpaid dividends, it can put a strain on the company’s finances. Additionally, the payment of the cumulative dividends can be seen as a sign of financial distress, which could hurt the company’s share price. Lastly, the payment of cumulative dividends can also decrease the company’s retained earnings, which could limit the company’s ability to reinvest in itself.

Other approaches related to Cumulative dividend

  • Dividend Reinvestment Plans (DRIPs): Dividend Reinvestment Plans (DRIPs) are plans whereby a company automatically reinvests a shareholders’ dividends by purchasing additional shares on the shareholders’ behalf. This allows shareholders to increase their ownership in the company without having to buy additional shares.
  • Stock Splits: A stock split is a corporate action in which a company divides its existing shares into multiple shares to boost the liquidity of the stock. This, in turn, makes the stock more affordable and accessible to a larger number of investors.
  • Stock Buybacks: A stock buyback occurs when a company repurchases its own shares from the open market. This reduces the number of shares outstanding and increases the value of the remaining shares. Stock buybacks are seen as a way for companies to return value to shareholders.

Cumulative dividends, Dividend Reinvestment Plans (DRIPs), stock splits and stock buybacks are all approaches that companies use to return value to shareholders. Cumulative dividends are a type of dividend payment in which all of the previously unpaid dividends are paid out to shareholders in a single lump sum. Dividend Reinvestment Plans (DRIPs) are plans whereby a company automatically reinvests a shareholders’ dividends by purchasing additional shares on the shareholders’ behalf. Stock splits are corporate actions in which a company divides its existing shares into multiple shares to boost the liquidity of the stock. Finally, stock buybacks are when a company repurchases its own shares from the open market. All of these approaches allow companies to return value to shareholders.


Cumulative dividend — recommended articles
Tax preference theory — Capital dividend — Bird-in-the-hand theory — Mezzanine capital — Fully Diluted Shares — Degree of financial leverage — Dividend irrelevance theory — Calendar spread — Refinancing

References

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