Dividend Decision: Meaning and Factors affecting Dividend Decision
Financial Management is concerned with the management of the flow of funds and involves decisions related to the acquisition and application of funds in long-term and short-term assets. It is concerned with two aspects, they are procurement of funds and usage of finance.
Financial decision refers to the decision related to financial matters of a business firm. There are various financial decisions that the firm makes to maximize shareholders’ wealth. There are three major decisions that every financial management takes investment decision, financial decision, and dividend decision.
The dividend is that portion of the profit that is distributed to the shareholders. The decision involved here is how much of the profit earned by the company after paying the taxes is to be distributed to the shareholders. It also includes the part of the profit that should be retained in the business. When the current income is re-invested, the retained earnings increase the firm’s future earning capacity. This extent of retained earnings also influences the financing decision of the firm. The dividend decision should be taken keeping in view the overall objective of maximizing shareholders’ wealth.
Factors affecting Dividend Decision
There are various factors that affect the dividend decision. These are as follows:
- Amount of Earnings: Dividends are paid out of the current and previous year’s earnings. More earnings will ensure greater dividends, whereas fewer earnings will lead to the declaration of a low rate of dividends.
- Stability of Earning: A company that is stable and has regular earnings can afford to declare higher dividend as compared to those company which doesn’t have such stability in earnings.
- Stability of Dividend: Some companies follow the policy of playing a stable dividend because it satisfies the shareholders and helps in increasing companies reputation. If earning potential is high, it is declared as a high dividend, whereas if the earning is temporary or not increasing, then it is declared as a low or normal dividend.
- Growth Opportunities: Companies with growth opportunities prefer to retain more money out of their earnings to finance the new project. So, companies that have growth prospects in near future will declare fewer dividends as compared to companies that don’t have any growth plan.
- Cash flow Position: Payment of dividends is related to the outflow of cash. A company may be profitable, but it may have a shortage of cash. In case the company has surplus cash, then the company can pay more dividends, but during a shortage of cash, the company can declare a low dividend.
- Taxation Policy: The rate of dividends also depends on the taxation policy of the government. In the present taxation policy, dividend income is tax-free income to the shareholders, so they prefer higher dividends. However, dividend decision is left to companies.
- Stock market reaction: The rate of dividend and market value of a share are directly related to each other. A higher rate of dividends has a positive impact on the market price of the shares. Whereas, a low rate of dividends may hurt the share price in the stock market. So, management should consider the effect on the price of equity shares while deciding the rate of dividend.
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