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What is a Cumulative Dividend?

Formula

Where,

  • Preferred Dividend Rate = The rate that is fixed by the company while issuing the shares.Preferred share Par Value = Preferred sharesPreferred SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more come with a par valuePar ValuePar value of shares is the minimum share value determined by the company issuing such shares to the public. Companies will not sell such shares to the public for less than the decided value.read more, that is the Face value of the share.

Features

  • The dividend payment amount is fixed. It doesn’t depend on the profit of the company. The pay-out is fixed irrespective of the particular year’s profitability.Unlike other shares, where the dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more is paid if the company makes a profit, cumulative preferred shares are paid even if the company doesn’t make a profit in a particular year. The fixed dividend is recorded in the financial statementsFinancial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more as payable and paid when the company makes a profit.Preferred shares receive the distribution of profit before common shareholders. So, whatever company earnings are left after this dividend is received by common shareholders.

How Does it Work?

Preferred dividends are paid before common dividends but after interest on the debt. The dividends that should be paid to the preferred shareholders get accumulated if the company doesn’t earn sufficient profit to pay them. Whenever the company earns a profit, it must clear the past accumulated dividends first, and then common shareholders can be paid.

Example of Cumulative Dividend

Let’s take an example.

Company XYZ issued 8% Cumulative Preferred shares with a Par value of $1,000 in 2016. Each year the company pays regular annual dividends. In 2018 and 2019, the company didn’t earn any profit and made a loss. Calculate the cumulative dividend that the company will have to pay to the preferred shareholders.

Solution:

The total Accumulated Dividend is 180; in 2020, if the company makes a profit, it will have to clear the total accumulation of 180 + 2020 preferred dividend, then common stockholders can be paid.

In 2018, the dividend will be

Dividend To be Paid = 8% * 1000 = 80

In 2019, cumulative dividend wil be –

Total Accumulated Dividend (2018 + 2019) will be –

Total Accumulated Dividend (2018 + 2019) = 80+ 80 =160

Reasons to Consider for Cumulative Dividend

  • Cumulative preferred shareholders know that they will receive dividends irrespective of the profitability of the companyProfitability Of The CompanyProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more for a particular year. So this gives confidence to the shareholders.As cumulative preferred shares are safe, the company can issue them at a lower dividend rate. This reduces the cost of the company.

Advantages

  • Shareholders know that they will receive dividends irrespective of the company’s profitability. So shareholders feel confident about the offering and participate in the issue.This is a cost-effective way for companies to raise capital. Unlike debenturesDebenturesDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. In return, investors are compensated with an interest income for being a creditor to the issuer.read more where the interest will have to be paid irrespective of the company incurring a loss, in this dividend, the companies get time for the payment, as the payment gets deferred until the company earns a profit.There is no maturity for cumulative preferred shares, so the company will not have to worry about principal repayment like debt.Shareholders often receive interest on this dividend, so they don’t lose money.A cumulative dividend comes before a common dividend, so preferred shareholders are safe.

This has been a guide to what cumulative dividend is and its definition. Here we discuss its formula and calculations along with an example, features, and advantages. You may learn more about financing from the following articles –

  • Special DividendDividend GrowthFranked DividendQualified Dividends