Cumulative Dividend

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What is a Cumulative Dividend?

A cumulative Dividend is a promise of paying a fixed percentage of earnings to the preferred shareholders. If due for any reason, the company cannot pay the dividend within the pre-decided date, then the dividend gets accumulated and is paid in the future.

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  • Cumulative dividend is a fixed percentage of earnings promised to preferred shareholders. If not paid within the designated timeframe, the unpaid dividend accumulates and is paid in the future.
  • The formula for the cumulative dividend is the preferred dividend rate multiplied by the preferred share par value. Unlike regular dividends tied to company profitability, cumulative dividends are fixed and paid even if the company doesn't profit in a specific year. They are recorded as payable and cleared when the company becomes profitable.
  • Cumulative preferred dividends are paid before common dividends but after debt interest. 

Formula

Cumulative Dividend Formula = Preferred Dividend Rate * Preferred Share Par Value

Where,

  • Preferred Dividend Rate = The rate that is fixed by the company while issuing the shares.
  • Preferred share Par Value = Preferred shares come with a par value, that is the Face value of the share.

Features

  1. 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.
  2. Unlike other shares, where the dividend 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 statements as payable and paid when the company makes a profit.
  3. 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

Example 1

Dividend To be Paid = 8% * 1000 = 80

In 2019, cumulative dividend wil be -

Example 1.1

Dividend To be Paid = 8% * 1000 = 80

Total Accumulated Dividend (2018 + 2019) will be -

Cumulative Dividend Example 1.1.5

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 company 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 debentures 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.

Frequently Asked Questions (FAQs)

1. What is cumulative vs. non-cumulative dividend?

Cumulative dividends are a type of preferred dividend where any unpaid dividends from previous periods accumulate and must be paid to shareholders before common shareholders receive dividends. On the other hand, non-cumulative dividends do not accumulate; if not paid in a given period, they are forfeited. Cumulative dividends provide more security to shareholders, while non-cumulative dividends offer greater flexibility to the company.

2. What is the difference between ex-dividend and cumulative dividend?

Ex-dividend refers to the date after which a buyer of a stock will not receive the upcoming dividend payment. Cumulative dividend refers to a type of preferred stock where any unpaid dividends accrue and must be paid before common shareholders receive dividends. The ex-dividend date is relevant to all dividend-paying stocks, whereas cumulative dividends specifically pertain to preferred shares with this feature.

3. Are cumulative dividends reported as a liability?

Yes, cumulative dividends are typically reported as a liability on the company's balance sheet. The cumulative amount of unpaid dividends represent an obligation to preferred shareholders, and therefore, it is listed as a liability until the dividends are paid.