Top Factors to Determine the Dividend Policy

Factors to Determine the Dividend Policy

Friends, we are all aware that when a limited company earns a lot of profits from its operations then they have to distribute those profits amongst the original owners of the company, i.e. among the shareholders.

However, it is important to note that a company is not required to distribute dividends to its shareholders if it does not wish to do so.

There is a possibility that the company will utilize that money to expand its business, which will be critical in the future.

However, if the company wants to distribute a percentage of its revenue to its shareholders then it must also have to develop a dividend policy to distribute its earnings. And that is the main reason why the role of the finance manager becomes very important in establishing a company’s dividend policy.

Before formulating any type of dividend policy for his company, a Finance manager has to take care of his 2 important factors and these two factors are named external factors and internal factors.

Today, through this article, we will try to give you some very important information about these two factors.

Factors to Determine the Dividend Policy

External Factors

(1) Phase of the Trade Cycle

If we talk more about the dividend policy, then how the business cycle of a company is working is become most important in the process of the formation of this policy. 

Suppose the company is undergoing a period of prosperity then it is possible that the company will distribute a significant portion of profits with its shareholders.

However, in the Indian market, companies often pay only a constant dividend, even during times of prosperity, and the remaining profit money is either kept into reserves or invested in future projects.

Many times, despite being in a period of prosperity, companies don’t really give a significant portion of their earnings to their shareholders because they pay a constant dividend to their shareholders even during a period of depression with the help of that saved profit and maintain their trust.

This policy is also known as the Defensive Dividend Policy. Defensive dividend policies are typically adopted by companies that do not have a strong business model and do not have a single consistent source of income.

(2) Legal Restrictions

As we all know, the stock market in India is entirely governed by a government entity known as SEBI and this government body has made various rules for the formation of dividend policy.

If a  company really wishes to pay dividends in cash to its shareholders then it must have to follow the requirements of the Companies Act 2013, and if the company wants to pay dividends in bonus shares then it must have to follow the relevant standards established by the SEBI.

Many times it also happens that because of all these rules, companies are hesitant to generate a significant extraordinary dividend policy and eventually later adopt a normal dividend policy.

(3) Investment Opportunities

In general, whenever a firm formulates a dividend policy, then the company actually takes care of its future strategy at the most prime level because one of the goals of every business is to maximize profit over a long period of time from their working business cycle.

And this is the main reason why one thing is certain: whenever a company believes it can create a significant return by investing its earnings somewhere else then it might be possible that the company may not pay dividends to its own shareholders.

Under these circumstances, the company also provides an excellent justification for its decision not to pay dividends to its shareholders in advance. And this is the main reason why only potential investors put their money after making their trust fundamental business model. 

(4) Tax Policy

When a company implements any kind of dividend policy for its shareholders then it also analyzes income tax policy.

The most essential point to understand about the dividend tax is that whenever a company pays out a dividend to its shareholders, it pays the dividend on an amount called “Profit after Tax”.

This is the main reason why it is particularly apparent that whenever a company distributes a dividend to its shareholders then the company does not get any kind of benefits from the income tax authorities.

Whenever any company pays a dividend to its shareholders then the one thing here we would like to mention is that even after paying tax to the Income-tax authority, a 12.5% tax must be paid on the amount of the dividend given, and over that percentage, 2 percentages of educational taxes also apply on it.

And when we talk from the perspective of the shareholders then it is quite obvious that they do not have to pay any kind of tax on the dividend amount paid by the firm.

Internal Factors

(1) Attitude of the Management

The approach of management is also very important in developing a dividend policy.

In general, when deciding on dividend policy, all types of personnel affiliated with the company’s primary management are polled for their thoughts on dividend distribution.

Many times, when people involved with management are aggressive in nature, and if they really think more about the interests of the shareholders then it is also possible that the company may pay the highest dividend to its shareholders.

However, if management’s strategy is particularly conservative and defensive then it is almost guaranteed that the company doesn’t really pay massive dividends to its shareholders and spends the money earned by the company for their future prospects. 

(2) Age of the company

By the way, If we determine then the company’s age has no direct impact on its dividend policy.

But one thing becomes very obsessive for you here: if a company is newly listed in the share market then the main goal of that company in its initial days is to expand its business by making the highest profit possible.

And this is the main reason why such businesses will never pay regular dividends to their shareholders and instead of paying that money to them, they will keep retain with themselves for future business operations.

If in comparison with the same a well-established company definitely pays dividends to its shareholders so that it maintains the confidence of its shareholders and can easily get funding in the coming future also.

Final Conclusion on Factors to Determine the Dividend Policy

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  1. Pingback: What is the Historical Evolution of Dividends? - Indian Apex

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