Determinants of Dividends

Policy and Dividend Policy

of Companies
Trend and Ratio Analysis
PRESENTED BY :
GROUP 8
WHAT IS  Dividend refers to the corporate net
profits distributed among shareholders.
DIVIDEND?  Dividends can be both preference
dividends and equity dividends.
 Preference dividends are fixed
dividends paid as a percentage every
year to the preference shareholders if
net earnings are positive.
 After the payment of preference
dividends, the remaining net profits are
paid or retained or both depending
upon the decision taken by the
management.
DETERMINANTS OF DIVIDEND
POLICY

Dividend Stability of Legal and

payout ratio dividends contractual

Capital
Age of the
market Inflation
company
considerations
 DIVIDEND PAYOUT RATIO

 Dividend payout ratio refers to the percent of net profit to be

distributed as dividends by the firm to the shareholders. The remaining
part of the earning is held by the firm for its further growth.

DP Ratio = Dividend paid to shareholders / Net profit of the firm

 Dividend policy involves the decision to pay out earnings or to retain

them for reinvestment in the firm.
 The retained earnings constitute a source of finance.
STABILITY OF DIVIDENDS

 Dividend stability refers to the payment of a certain

minimum amount of dividend regularly.
 Stability of dividend means how regular or stable is the
dividend policy of a firm over a period of time.
 Shareholders prefer stable dividends along with some
growth in those dividends.
 If a firm is able to pay dividends in a such a way then the
cost of shares will increase.
 LEGAL AND CONTRACTUAL
CONSTAINTS

 Companies Act 2013, sections & instructions must be followed.

 Dividend can be paid either as :
• Final Dividend, that is paid after the annual general meeting of the firm
after analyzing the earnings.
• Interim Dividend, that is paid in between the two Annual General
Meetings of a firm, if firm seems to generate expected profits.
 Dividend is paid from the earnings of present year.
 Once the dividend amount is declared, that must be paid to the
shareholders within 30 days.
AGE OF THE COMPANY

 The age of the company also influences the dividend decision

of a company.

 A newly established concern has to limit payment of dividend

and retain substantial part of earnings for financing its future
growth and development, while older companies which have
established sufficient reserves can afford to pay liberal
dividends
 CAPITAL MARKET CONSIDERATIONS

 The extent to which the firm has access to the capital markets,
also affects the dividend policy.
 In case the firm has easy access to the capital market, it can
follow a liberal dividend policy.
 If the firm has only limited access to capital markets, it is likely to
adopt a low dividend payout ratio.
 Such companies rely on retained earnings as a major source of
financing for future growth.
INFLATION

 With rising prices due to inflation, the funds generated

from depreciation may not be sufficient to replace
obsolete equipment and machinery.
 So, they may have to rely upon retained earnings as
a source of fund to replace those assets.
 Thus, inflation affects dividend payout ratio in the
negative side.
INTRODUCTION TO DIVIDEND
POLICY

 Dividend policy is set of guidelines a company uses to decide

how much of its earning it will pay out to shareholders.

 Dividend policy implies companies through their board of

directors evolve a defined pattern of dividend payments which
has bearing on further actions.

 Dividend paid out of profit .these could either be profit of the

current year or the accumulated profit of the past.
GOALS OF DIVIDEND POLICY

 Dividend policy should be analyzed in terms of its

effect on the value of the company
 Dividend decision should not be treated as short run
residual decision.
 Frequent changes in dividend should be avoided.
 Dividend, investment and financing decision are
interdependent and there is often tradeoff.
 APPROACHES TO DIVIDEND POLICY

Gordon’s model
 Given by Myron Gordon S.
 Gordon’s theory on dividend policy states that company dividend payout
policy and the relationship between its rates of return (r) and cost of capital
(k)influence the market price per share of the company.
Assumptions :
• Rate of return r and cost of capital k is constant.
• Life of firm is indefinite
• Growth rate is constant
• Cost of capital greater than br
P=[E(1-P)]/ke-br
Where, p= price of share
e = earning per share
B= retention ratio
1-b=proportion of earning distributed as dividends
Ke=capitalization rate
Br =growth rate
MODIGLIANI’S APPROACH

 It was proposed in 1961. Modigliani’s model assumes that the

dividend are irrelevant theory.

Assumptions:
 No taxes – there is no existence of taxes.
 Fixed investment policy
 No risk of uncertainity
 Perfect capital market.
 P1=Po*(1+ke)-D1
 P1=market price of the share at the end of the
period
 Po=market price of share at the beginning of a
period
 Ke=cost of capital
 D1=dividend received at the end of the period
RATIO ANALYSIS

Ratio analysis: An analytical technique

that typically involves a comparison of
the relationship between two financial
items.
OBJECTIVES OF RATIO
ANALYSIS

 Standardize financial information for comparisons

 Evaluate current operations
 Compare performance with past performance
 Compare performance against other firms or
industry standards
 Study the efficiency of operations
TYPES OF FINANCIAL RATIOS

Liquidity Ratios.
Asset Management Ratios (Activity Ratios).
Profitability Ratios.
 LIQUIDITY RATIOS

 A liquid asset is one that can be easily converted into cash at a fair market value.

 Liquidity question deals with this question

• Will the firm be able to meet its current obligations?

 Two measures of liquidity:

• Current Ratio
• Quick/Acid Test Ratio
 LIQUIDITY RATIOS

 Current ratio = Current assets / Current liabilities

Purpose: Measures a firm’s ability to pay its

current liabilities from its current assets.
• Quick (Acid Test) Ratio = Current assets - Inventories / Current liabilities

Purpose: Measures a firm’s ability to pay its current liabilities without

relying on the sale of its inventory.
ASSET MANAGEMENT RATIOS

 Asset management ratio measures how effectively the firm is

managing/using its assets
 Do we have too much investment in assets or too little
investment in assets in view of current and projected sales levels?
 What happens if the firm has
• Too much investment in assets
• Too little investment in assets
ASSET MANAGEMENT RATIOS

The Inventory Turnover Ratio= Sales/ Inventory.

Purpose: Indicates the number of times that a firm sells its
inventory each year.
 Measures the efficiency of Inventory Management
 A high ratio indicates that inventory does not remain in warehouses or
on shelves, but rather turns over rapidly into sales
 ASSET MANAGEMENT RATIOS

The Fixed Assets Turnover Ratio= Sales/ Net Fixed Assets

Purpose: to measure how effectively the firm uses its plant

and equipment to generate sales.
Total Asset Turnover Ratio= Sales/ Total Assets

Purpose: Measure efficiency of total assets for the

company as a whole or for a division of the firm.
PROFITABILITY RATIOS

 Net result of a number of policies and decisions

 Show the combined effect of liquidity, asset

management, and debt management on operating
results
Profit Margin on Sales = Net Income/ Sales

Purpose: Indicates the percentage of each sales dollar

that contributes to net income.

 Relates net income available to common stockholders to sales

Return on Assets (ROA) = Net Income/ Total Assets
Purpose: Measures the rate of return a firm realizes on its
investment in assets.

Relates net income available to common stockholders

to total assets
Return on Common Equity (ROE) = Net Income/ Common Equity

Purpose: Measures the rate of return on a firm’s stockholders’ equity.

 Relatesnet income available to common stockholders to common

stockholders equity
 TREND ANALYSIS

 The study of percentage changes in financial statement items

over a period of time.

 Trend analysis provides a simple forecasting method.

 Used to estimate the likelihood of improvement or deterioration

in its financial conditions.
THANKYOU