Dividend decision is one of the most important financing decisions of the company. A company should have either a policy on the distribution of profits (Reserve) among the investor or a policy on retention the profits (reserve). The potential investors of the company are more interested to know the implications of investing in the company.
The company should have to make a decision between the making payments to shareholders and retaining the funds for the future.
The factors affecting the dividend decision are the following:
Earnings: – The Company distribute the dividend among the shareholders out of the present and reserved profits. Therefore, the greater amount of the profits will ensure greater dividend.
Stability Earnings: – Stable earning of the company affecting the dividend decision of the company. If a company having stable earning is in the position to declare more dividends during the period. If a company having low earnings during a period then it will be not in a position to declare the dividend.
Growth opportunity: – If the company have more opportunity for growth and expansion, then the company will require more finance. In such a case, the company should retain the large part of the earnings and a small part of it should be paid out as a dividend to the investors of the company.
Cash flow position:-The cash flow position of the company affecting the dividend decision of the company. The more payments of the dividend to the investors results in outflows of cash. It is possible that company may have enough income but on other, it will be equally possible that a company may not have sufficient cash to pay the dividend.
So in such a way the cash flow position affecting the dividend decision. If the company have a better cash flow position, the better will be the capacity of the business to pay out the dividend and on vice-versa.
Shareholders preference: – The shareholders’ preference also affecting the dividend decision of the company. There are two kinds of shareholders-
(1) those shareholders who invest in the company with the purpose of getting regular income
(2) those shareholders who invest in the company with the purpose of gain capital profits. If the majority of the shareholders are investing in the company with the purpose of getting regular income then in such case the company should declare dividend according to their expectations.
On another hand, if the majority of the shareholders of the latter type the company enjoy freedom about declaring the dividend.
Taxation policy: – Dividend decision of the company depends on the taxation policy of the government. If the tax rate is higher on the dividend then the company should pay out less dividend and vice-versa.
But nowadays dividend income is tax-free in the hands of shareholders. So that shareholder likes to get the higher dividend.