Dinidend Policy

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Dividend PolicyOnce a company makes a profit, management must decide on what to do with those profits.

They could continue to retain the profits within the company, or they could pay out the

profits to the owners of the firm in the form of dividends.

Once the company decides on whether to pay dividends they may establish a somewhat

permanent dividend policy, which may in turn impact on investors and perceptions of the

company in the financial markets. What they decide depends on the situation of the company

now and in the future. It also depends on the preferences of investors and potential investors.

DINIDEND POLICY:

Dividend policy is concerned with taking a decision regarding payingcash dividend in

the present or paying an increased dividend at a later stage. The firm could also pay in the

form ofstock dividends which unlike cash dividends do not provide liquidity to the

investors, however, it ensures capital gains to the stockholders. The expectations of

dividends by shareholders helps them determine the share value, therefore, dividend

policy is a significant decision taken by the financial managers of any company.

Dividend policySKF's dividend and distribution policy is based on the principle that the

total dividend should be adapted to the trend for earnings and cash flow, while taking into

account the Group's development potential and financial position.

The Board of Directors' view is that the ordinary dividend should amount to around 50%

of SKF's average net profit calculated over a business cycle.

If the financial position of the SKF Group exceeds the targets stated above, an additional

distribution to the ordinary dividend could be made in the form of a higher dividend, a

redemption scheme or a repurchase of the company's own shares. On the other hand, in

periods of more uncertainty a lower dividend ratio could be appropriate.

Dividend 2012

The Board has decided to propose an unchanged dividend of SEK 5.50 per share to the

Annual General Meeting.

For foreign shareholders, withholding tax rate

The statutory witholding tax rate is 30%, but that rate is usually reduced depending on the

applicable tax treaty.
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Our policy of growing the US dollar dividend at least in line with inflation changed

at the beginning of 2010. The new policy is to grow the US dollar dividend in line

with our view of the underlying earnings and cash flow of Shell.

When setting the dividend, the Board of Directors looks at a range of factors, including

the macro environment, the current balance sheet and future investment plans. In

addition, we may choose to return cash to shareholders through share buybacks, subject

to the capital requirements of Shell. It is our intention that dividends will be declared and

paid quarterly.

Dividends are declared in US dollars and we announce the euro and sterling equivalent

amounts at a later date.

Dividends declared on Class A shares are paid by default in Euros, although holders of

Class A shares are able to elect to receive dividends in sterling.

Dividends declared on Class B shares are paid by default in sterling, although holders

of Class B shares are able to elect to receive dividends in Euros.

Dividends declared on ADSs are paid in US dollars.

In September 2010, Shell introduced a Scrip Dividend Programme that enables

shareholders to increase their shareholding by choosing to receive any dividends declared

by the Board in the form of new shares instead of cash. Under the Scrip Dividend

Programme, shareholders can increase their shareholding in Shell by choosing to receive

new shares instead of cash dividends if declared by Shell.

Shareholders who do not join the Scrip Dividend Programme will continue to receive in

cash any dividends declared by Shell.

For further information on the Scrip Dividend Programme please refer

to www.shell.com/scrip.

Please refer to the dividend timetable dividend timetable for dates relevant to Shells

dividend and Shells Scrip Dividend Programme.
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Concept:

Coming up with a dividend policy is challenging for the directors and financial manager a

company, because different investors have different views on present cash dividends andfuture capital gains. Another confusion that pops up is regarding the extent of effect of

dividends on the share price. Due to this controversial nature of a dividend policy it is

often called the dividend puzzle.

Various models have been developed to help firms analyse and evaluate the perfect

dividend policy. There is no agreement between these schools of thought over the

relationship between dividends and the value of the share or the wealth of the

shareholders in other words.

One school consists of people like James E. Walter and Myron J. Gordon (see Gordon

model), who believe that current cash dividends are less risky than future capital gains.

Thus, they say that investors prefer those firms which pay regular dividends and such

dividends affect the market price of the share. Another school linked to Modigliani and

Millerholds that investors don't really choose between future gains and cash dividends.

]Relevance of dividend policy

Dividends paid by the firms are viewed positively both by the investors and the firms.

The firms which do not pay dividends are rated in oppositely by investors thus affecting

the share price. The people who support relevance of dividends clearly state that regular

dividends reduce uncertainty of the shareholders i.e. the earnings of the firm is

discounted at a lower rate, ke thereby increasing the market value. However, its exactly

opposite in the case of increased uncertainty due to non-payment of dividends.

Two important models supporting dividend relevance are given by Walter and Gordon.
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Goutham's model:

Goutham Manimaran's model shows the relevance of dividend policy and its bearing onthe value of the share

Assumptions of the Walter model

Retained earnings are the only source of financing investments in the firm, there

is no external finance involved.

The cost of capital, k e and the rate of return on investment, r are constant i.e.

even if new investments decisions are taken, the risks of the business remains same.

The firm's life is endless i.e. there is no closing down.

Basically, the firm's decision to give or not give out dividends depends on whether it has

enough opportunities to invest the retain earnings i.e. a strong relationship between

investment and dividend decisions is considered.

Model description

Dividends paid to the shareholders are re-invested by the shareholder further, to gethigher returns. This is referred to as the opportunity cost of the firm or the cost of capital,

ke for the firm. Another situation where the firms do not pay out dividends, is when they

invest the profits or retained earnings in profitable opportunities to earn returns on such

investments. This rate of return r, for the firm must at least be equal to ke. If this happens

then the returns of the firm is equal to the earnings of the shareholders if the dividends

were paid. Thus, its clear that if r, is more than the cost of capital ke, then the returns

from investments is more than returns shareholders receive from further investments.

Walter's model says that if rke then the investment

opportunities reap better returns for the firm and thus, the firm should invest the retained

earnings. The relationship between r and k are extremely important to determine the

dividend policy. It decides whether the firm should have zero payout or 100% payout.


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In a nutshell :

If r>ke, the firm should have zero payout and make investments.

If r


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Main article: Gordon model

Myron J. Gordon

Myron J. Gordon has also supported dividend relevance and believes in regular dividends

affecting the share price of the firm.[2]

The Assumptions of the Gordon model

Gordon's assumptions are similar to the ones given by Walter. However, there are two

additional assumptions proposed by him :

The product of retention ratio b and the rate of return r gives us the growth rate of

the firm g.

The cost of capital ke, is not only constant but greater than the growth rate i.e.

ke>g.

Model description

Investor's are risk averse and believe that incomes from dividends are certain rather than

incomes from future capital gains, therefore they predict future capital gains to be risky

propositions. They discount the future capital gains at a higher rate than the firm's

earnings thereby, evaluating a higher value of the share. In short, when retention rate

increases, they require a higher discounting rate. Gordon has given a model similar to

Walter's where he has given a mathematical formula to determine price of the share.

Mathematical representation

The market price of the share is calculated as follows:

where,

P = Market price of the share

E = Earnings per share

b = Retention ratio (1 - payout ratio)

r = Rate of return on the firm's investments

ke = Cost of equity
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br = Growth rate of the firm (g)

Therefore the model shows a relationship between the payout ratio, rate of return, cost of

capital and the market price of the share.

Conclusions on the Walter and Gordon Model

Gordon's ideas were similar to Walter's and therefore, the criticisms are also similar. Both

of them clearly state the relationship between dividend policies and market value of the

firm.

Capital structure substitution theory & dividends

The capital structure substitution theory(CSS)[3] describes the relationship betweenearnings, stock price and capital structureof public companies. The theory is based on

one simple hypothesis: company managements manipulate capital structure such that

earnings-per-share (EPS) are maximized. The resulting dynamic debt-equity target

explains why some companies use dividends and others do not. When redistributing cash

to shareholders, company managements can typically choose between dividends

andshare repurchases. But as dividends are in most cases taxed higher than capital gains,

investors are expected to prefer capital gains. However, the CSS theory shows that for

some companies share repurchases lead to a reduction in EPS. These companies typically

prefer dividends over share repurchases.

Mathematical representation

From the CSS theory it can be derived that debt-free companies should prefer

repurchases whereas companies with a debt-equity ratio larger than

should prefer dividends as a means to distribute cash toshareholders, where

D is the companys total long term debt

is the companys total equity

is the tax rate on capital gains

is the tax rate on dividends
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Low valued, high leverage companies with limited investment opportunities and a high

profitability use dividends as the preferred means to distribute cash to shareholders, as is

documented by empirical research.

Conclusion

The CSS theory provides more guidance on dividend policy to company managements

than the Walter model and the Gordon model. It also reverses the traditional order of

cause and effect by implying that company valuation ratios drive dividend policy, and not

vice-versa. The CSS theory does not have 'invisible' or 'hidden' parameters such as

the equity risk premium, the discount rate, the expected growth rate or expected inflation.

As a consequence the theory can be tested in an unambiguous way.

[edit]Irrelevance of dividend policy

Franco Modigliani

Merton Miller

The Modigliani andMillerschool of thought believes that investors do not state any

preference between current dividends and capital gains. They say that dividend policy is

irrelevant and is not deterministic of the market value. Therefore, the shareholders are

indifferent between the two types of dividends. All they want are high returns either in

the form of dividends or in the form of re-investment of retained earnings by the firm.

There are two conditions discussed in relation to this approach :

Decisions regarding financing and investments are made and do not change with

respect to the amounts of dividends received.

When an investor buys and sells shares without facing any transaction costs and

firms issue shares without facing any floatation cost, it is termed as a perfect capital

market.[5]
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Two important theories discussed relating to the irrelevance approach, the residuals

theory and the Modigliani and Miller approach.

Residuals theory of dividendsOne of the assumptions of this theory is that external financing to re-invest is either not

available, or that it is too costly to invest in any profitable opportunity. If the firm has

good investment opportunity available then, they'll invest the retained earnings and

reduce the dividends or give no dividends at all. If no such opportunity exists, the firm

will pay out dividends.

If a firm has to issue securities to finance an investment, the existence of floatation costs

needs a larger amount of securities to be issued. Therefore, the pay out of dividends

depend on whether any profits are left after the financing of proposed investments as

floatation costs increases the amount of profits used. Deciding how much dividends to be

paid is not the concern here, in fact the firm has to decide how much profits to be retained

and the rest can then be distributed as dividends. This is the theory of Residuals, where

dividends are residuals from the profits after serving proposed investments. [6]

This residual decision is distributed in three steps:

Evaluating the available investment opportunities to determine capital

expenditures.

Evaluating the amount of equity finance that would be needed for the investment,

basically having an optimum finance mix.

Cost of retained earnings


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investment opportunities available to the company

Amount of internally retained and generated funds which lead to dividend

distribution if all possible investments have been financed.

The dividend policy of such a kind is a passive one, and doesn't influence market price.

The dividends also fluctuate every year because of different investment opportunities

every year. However, it doesn't really affect the shareholders as they get compensated in

the form of future capital gains.

Conclusion

The firm paying out dividends is obviously generating incomes for an investor, however

even if the firm takes some investment opportunity then the incomes of the investors rise

at a later stage due to this profitable investment.

Modigliani-Miller theorem

Main article: ModiglianiMiller theorem

The ModiglianiMiller theoremstates that the division of retained earnings between new

investment and dividends do not influence the value of the firm. It is the investment

pattern and consequently the earnings of the firm which affect the share price or the value

of the firm.[7]

Assumptions of the MM theorem

The MM approach has taken into consideration the following assumptions:

There is a rational behavior by the investors and there exists perfect capital

markets.

Investors have free information available for them.

No time lag and transaction costs exist.

Securities can be split into any parts i.e. they are divisible

No taxes and floatation costs.

The investment decisions are taken firmly and the profits are therefore known

with certainty. The dividend policy does not affect these decisions.

Model description
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The dividend irrelevancy in this model exists because shareholders are indifferent

between paying out dividends and investing retained earnings in new opportunities. The

firm finances opportunities either through retained earnings or by issuing new shares to

raise capital. The amount used up in paying out dividends is replaced by the new capital

raised through issuing shares. This will affect the value of the firm in an opposite ways.

The increase in the value because of the dividends will be offset by the decrease in the

value for new capital rising.

Types of Dividend Policies

A policy is a guideline for action. What are the guidelines followed in respect of dividend

function? The guidelines relate to forms, scale, stability and timing of dividend payment.

Accordingly dividend policies of diverse nature are available. Prominent of them are

dealt with below.

Policy of No Immediate Dividend: Generally, management follows a policy of

paying no immediate dividend in the beginning of its life, as it requires funds for

growth and expansion. In case, when the outside funds are costlier or when the access

to capital market is difficult for the company and shareholders are ready to wait for

dividend for sometime, this policy is justified, provided the company is growing fast

and it requires a good deal of amount for expansion. But such a policy is not justified

for a long time, as the shareholders are deprived of the dividend and the retained

earnings built up which will attract attention of laborers, consumers etc. It would be

better if the period of dividend is followed by issue of bonus shares, so that later on

rate of dividend is maintained at a reasonable level.


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Regular or Stable Dividend Policy: When a company pays dividend regularly at a

fixed rate, and maintains it for a considerably long time even though the profits may

fluctuate, it is said to follow regular or stable dividend policy. Thus stable dividend

policy means a policy of paying a minimum amount of dividend every year regularly.

It raises the prestige of the company in the eyes of the investors. A firm paying stable

dividend can satisfy its shareholders and can enhance its credit standing in the market.

Not only that the dividend must be regularly paid but the dividend must be stable. It

may be fixed amount per share or a fixed percentage of net profits or it may be total

fixed amount of dividend on all the shares etc. The benefits of stable dividend policy

are (1) it helps in raising long-term finance. When the company tries to raise finance in

future, the investors would examine the dividend record of the company. The investors

would not hesitate to invest in company with stable dividend policy. (2) As it will

enhance the prestige of the company, the price of its shares would remain at a high

level. (3) The shareholders develop confidence in management. (4) It makes long-term

planning easier.

Regular Dividend plus Extra Dividend Policy. A firm paying regular dividends

would continue with its pay out ratio. But when the earnings exceed the normal level,

the directors would pay extra dividend in addition to the regular dividend. But it would

be named Extra dividend, as it should not give an impression that the company hasenhanced rate of regular dividend, This would give an impression to shareholders that

the company has given extra dividend because it has earned extra profits and would

not be repeated when the business earnings become normal. Because of this policy, the

companys prestige and its share values will not be adversely affected. Only when the

earnings of the company have permanently increased, the extra dividend should be

merged with regular normal dividend and thus rate of normal dividend should be

raised. Besides, the extra dividend should not be abruptly declared, but the

shareholders should have some idea in advance, so that they may sell their shares, if

they like. This system is not found in India.

Irregular Dividend Policy: When the firm does not pay out fixed dividend regularly,

it is irregular dividend policy. It changes from year to year according to changes in

earnings level. This policy is based on the management belief that dividend should be


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paid only when the earnings and liquid position of the firm warrant it. This policy is

followed by firms having unstable earnings, particularly engaged in luxury goods.

Regular Stock Dividend Policy: When a firm pays dividend in the form of shares

instead of cash regularly for some years continuously, it is said to follow this policy.

We know stock dividend as bonus shares. When a company is short of cash or is

facing liquidity crunch, because a large part of its earnings are blocked in high level of

receivables or when the company is need of cash for its modernization and expansion

program, it follows this policy. It is not advisable to follow this policy for a long time,

as the number of shares will go on increasing, which would result in fall in earnings

per share. This would adversely affect the credit standing of the firm and its share

values will go down.

Regular Dividend plus Stock Dividend Policy: A firm may pay certain amount of dividend in cash

and some dividend is paid in the form of shares (stock). Thus, the dividend is split in to two parts. This

policy is justified when (1) The company wants to maintain its policy of regular dividend and yet (2) It

wants to retain some part of its divisible profit with it for expansion. (3) It wants to give benefit of its

earnings to shareholders but has not enough liquidity to give full dividend in cash. All the limitations of

paying regular stock dividends apply to this policy.

Liberal Dividend Policy: It is a policy of distributing a major part of its earnings to its shareholders as

dividend and retains a minimum amount as retained earnings. Thus, the ratio of dividend distribution is

very large as compared to retained earnings. The rate of dividend or the amount of dividend is not fixed.

It varies according to earnings. The higher is the profit, the higher will be the rate of dividend. In years

of poor earnings, the rate of dividend will be lower. In fact, it is the policy of Irregular Dividend.

Factors affecting dividend policy?

Dividend Decision

Dividend

Meaning: Dividend is that part of the profits of a company which is distributed amongst


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its shareholders.

Definition: According to ICAI, "Dividend is a distribution to shareholders out of profits

or reserves available for this purpose."

Nature of Dividend Decision

The dividend decision of the firm is crucial for the finance manager because it

determines:

1. the amount of profit to be distributed among the shareholders, and

2. the amount of profit to be retained in the firm.

There is a reciprocal relationship between cash dividends and retained earnings.

While taking the dividend decision the management take into account the effect of the

decision on the maximization of shareholders' wealth.

Maximizing the market value of shares is the objective.

Dividend pay out or retention is guided by this objective.

Dividend Policy

Factors Affecting Dividend Policy:

1. External Factors

2. Internal Factors

External Factors Affecting Dividend Policy

1.General State of Economy:

In case of uncertain economic and business conditions, the management may like to

retain whole or large part of earnings to build up reserves to absorb future shocks.

In the period of depression the management may also retain a large part of its earnings

to preserve the firm's liquidity position.


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In periods of prosperity the management may not be liberal in dividend payments

because of availability of larger profitable investment opportunities.

In periods of inflation, the management may retain large portion of earnings to finance

replacement of obsolete machines.

2.State of Capital Market:

Favourable Market: liberal dividend policy.

Unfavourable market: Conservative dividend policy.

3.Legal Restrictions:

Companies Act has laid down various restrictions regarding the declaration of dividend:

Dividends can only be paid out of:

** Current or past profits of the company.

Money provided by the State/ Central Government in pursuance of the guarantee

given by the Government.

Payment of dividend out of capital is illegal.

A company cannot declare dividends unless: ** It has provided for present as well as all arrears of depreciation.

Certain percentage of net profits has been transferred to the reserve of the company.

Past accumulated profits can be used for declaration of dividends only as per the rules

framed by the Central Government

4.Contractual Restrictions:

interests (especially when the firm is experiencing liquidity problems)

Example:

A loan agreement that the firm shall not declare any dividend so long as the liquidity ratio

is less than 1:1.


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The firm will not pay dividend more than 20% so long as it does not clear the loan.

Internal Factors affecting dividend decisions

1. Desire of the Shareholders

Though the directors decide the rate of dividend, it is always at the interest of the

shareholders.

Shareholders expect two types of returns:

[i] Capital Gains: i.e., an increase in the market value of shares.

[ii] Dividends: regular return on their investment.

Cautious investors look for dividends because,

[i] It reduces uncertainty (capital gains are uncertain).

[ii] Indication of financial strength of the company.

[iii] Need for income: Some invest in shares so as to get regular income to meet their

living expenses.

2. Financial Needs of the Company:

If the company has profitable projects and it is costly to raise funds, it may decide

to retain the earnings.

3.Nature of earnings:

A company which has stable earnings can afford to have an higher divided payout

ratio

4.Desire to retain the control of management:

Additional public issue of share will dilute the control of management.

5.Liquidity position:

Payment of dividend results in cash outflow. A company may have adequate


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earning but it may not have sufficient funds to pay dividends

Stability of Dividends

The term stability of dividends means consistency in the payment of dividends. It

refers to regular payment of a certain minimum amount as dividend year after

year.

Even if the company's earnings fluctuate from year to year, its dividend should

not. This is because the shareholders generally value stable dividends more than

fluctuating ones.

Stable dividend can be in the form of:

1. Constant dividend per share

2. Constant percentage

3. Stable rupee dividend plus extra dividend

Significance of Stability of Dividend

1. Desire for current income

2. Sign of financial stability of the company

3. Requirement of institutional investors

4. Investors confidence in the company

Factors Affecting Dividend Policy Of A Firm

A firm's dividend policy is influenced by the large numbers of factors. Some factors

affect the amount of dividend and some factors affect types of dividend. The following

are the some major factors which influence the dividend policy of the firm.

1. Legal requirements
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There is no legal compulsion on the part of a company to distribute dividend. However,

there certain conditions imposed by law regarding the way dividend is distributed.

Basically there are three rules relating to dividend payments. They are the net profit rule,

the capital impairment rule and insolvency rule.

2. Firm's liquidity position

Dividend payout is also affected by firm's liquidity position. In spite of sufficient retained

earnings, the firm may not be able to pay cash dividend if the earnings are not held in

cash.

3. Repayment need

A firm uses several forms of debt financing to meet its investment needs. These debt

must be repaid at the maturity. If the firm has to retain its profits for the purpose of

repaying debt, the dividend payment capacity reduces.

4. Expected rate of return

If a firm has relatively higher expected rate of return on the new investment, the firm

prefers to retain the earnings for reinvestment rather than distributing cash dividend.

5. Stability of earning

If a firm has relatively stable earnings, it is more likely to pay relatively larger dividend

than a firm with relatively fluctuating earnings.

6. Desire of controlWhen the needs for additional financing arise, the management of the firm may not prefer

to issue additional common stock because of the fear of dilution in control on

management. Therefore, a firm prefers to retain more earnings to satisfy additional

financing need which reduces dividend payment capacity.


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7. Access to the capital market

If a firm has easy access to capital markets in raising additional financing, it does not

require more retained earnings. So a firm's dividend payment capacity becomes high.

8. Shareholder's individual tax situation

For a closely held company, stockholders prefer relatively lower cash dividend because

of higher tax to be paid on dividend income. The stockholders in higher personal tax

bracket prefer capital gain rather than dividend gains.

Dividend and determinants of Dividend Policy

Dividend

Dividend refers to the corporate net profits distributed among shareholders. 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

The main determinants of dividend policy of a firm can be classified into:

Dividend payout ratio

Stability of dividends

Legal, contractual and internal constraints and restrictions

Owner's considerations

Capital market considerations and

Inflation.


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Dividend payout ratio

Dividend payout ratio refers to the percentage share of the net earnings distributed

to the shareholders as dividends. 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. The optimum dividend policy should strike a

balance between current dividends and future growth which maximizes the price

of the firm's shares. The dividend payout ratio of a firm should be determined

with reference to two basic objectives maximizing the wealth of the firms

owners and providing sufficient funds to finance growth. These objectives are

interrelated.

Stability of dividends

Dividend stability refers to the payment of a certain minimum amount of dividend

regularly. The stability of dividends can take any of the following three forms:

constant dividend per share

constant dividend payout ratio or

constant dividend per share plus extra dividend

Legal, contractual and internal constraints and restrictions

Legal stipulations do not require a dividend declaration but they specify the

conditions under which dividends must be paid. Such conditions pertain to capital

impairment, net profits and insolvency. Important contractual restrictions may be

accepted by the company regarding payment of dividends when the company

obtains external funds. These restrictions may cause the firm to restrict the

payment of cash dividends until a certain level of earnings has been achieved or

limit the amount of dividends paid to a certain amount or percentage of earnings.

Internal constraints are unique to a firm and include liquid assets, growth

prospects, financial requirements, availability of funds, earnings stability and

control.

Owner's considerations


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The dividend policy is also likely to be affected by the owner's considerations of

the tax status of the shareholders, their opportunities of investment and the

dilution of ownership.

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 equipments 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.

Danger of Stable Dividend Policy

Stable dividend policy may sometimes prove dangerous. Once a stable dividend policy is

adopted by a company, any adverse change in it may result in serious damage regarding

the financial standing of the company in the mind of the investors.

Forms of Dividend

1.Cash Dividend:

The normal practice is to pay dividends in cash.

The payment of dividends in cash results in cash outflow from the firm. Therefore the

firm should have adequate cash resources at its disposal before declaring cash dividend.

2.Stock Dividend:

The company issues additional shares to the existing shareholders in proportion to their

holdings of equity share capital of the company.


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Stock dividend is popularly termed as 'issue of bonus shares.'

This is next to cash dividend in respect of its popularity.

3.Bond Dividend:

In case the company does not have sufficient funds to pay dividends in cash it may issue

bonds for the amount due to shareholders.

The main purpose of bond dividend is postponement of payment of immediate dividend

in cash. The bond holders get regular interest on their bonds besides payment of the bond

money on the due date.

[Bond dividend is not popular in India]

4.Property Dividend:

This is a case when the company pays dividend in the form of assets other than cash. This

may be in the form of certain assets which are not required by the company or in the form

of company's products.

[This type of dividend is not popular in India]

Bonus Shares

When the additional shares are allotted to the existing shareholders without receiving any

additional payment from them, is known as issue of bonus shares.

Bonus shares are allotted by capitalizing the reserves and surplus.

Issue of bonus shares results in the conversion of the company's profits into share capital.

Therefore it is termed as capitalization of company's profits.

Since such shares are issued to the equity shareholders in proportion to their holdings of

equity share capital of the company, a shareholder continues to retain his/ her

proportionate ownership of the company.

Issue of bonus shares does not affect the total capital structure of the company. It issimply a capitalization of that portion of shareholders' equity which is represented by

reserves and surpluses.

It also does not affect the total ea


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Factors Affecting Working Capital

Posted: May 9th, 2011 | Rating: 3.8/5 | Views: 9930 | Rank Points: 100290 |

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The working capital requirements of a business depends upon a number of factors which

in brief are as under:-

(1) Nature of the business. The working capital requirements of an enterprise

basically depends upon the nature of its business and operating cycle of the business. A

trading concern, for instance, requires large amount of working capital for investment in

stocks, receivables and cash etc. It requires less investments in fixed assets. A business

where the proportion of cost of raw material to be consumed to total cost of production is

high, the amount of working capital required is large, shipbuilding for instance.

(2) Size of the business. The amount of working capital needed depends upon the

scale of operation of the business. The larger the size of the business unit, generally the

larger is the requirement of working capital and vice versa.

(3) Length of period of manufacture. If the goods are tied up for a longer period of

time in. the production process such as ship building, heavy armaments, aeroplanes etc.,

it requires a large amount of working capital to meet the manufacturing expenses until the

payment is received for the finished products. In case of short manufacturing process of a

commodity such as cloth, shoes etc. the capital is not tied for a longer period and as such

the amount of circulating capital will be small compared to the ship building industry.

(4) Methods of purchase and sale of commodities. If a business is able to

purchase the raw material and other allied products on credit and is able to sell the
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manufactured goods on cash it will need less amount of working capital In case the raw

material is purchased on cash and goods are sold on credit the amount of required

working capital would be large.

(5) Converting working assets into cash. If the assets of a business have liquidity

i.e. they are readily saleable for cash then less amount will be set aside for working

capital. In case the assets are not quickly saleable for cash then a greater amount f

working capital will be required by it.

(6) Seasonal variation in business. There are certain industries which purchase raw

material in the production season such as cotton, rubber and consume the material in the

off season for the manufacturing of products. These industries require large amount of

working capital to purchase the raw material in a production season and pay the wage

costs in the off season.

(7) Risk in business. A business like the oil exploration involves great risk. The

business may or may not be able to find out the oil by digging of wells: The business

needs huge amount of working capital in such risky enterprises.

(8) Size of labour force. If the size of labour force employed in the manufacture of a

product is fairly, large, (labour intensive), the business will need a greater amount of

working capital. In capital intensive industries lesser amount of working capital is

required.

(9) Price level changes. If the prices are rising very rapidly in the country the business

will require greater amount of working capital to maintain the same current assets and

vice versa.


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(10) Rate of turnover. If in a business, the sale is faster i.e., a business has rapid turn

over then the amount of working capital required may be small as cash is realized from

sales. A business where the rate of turn over is slow there is more requirement of working

capital in that business.

(11) State of business activity. When the business is prosperous it needs more

working capital for increasing the volume of business. On the contrary when the business

is slack and sales decline then less amount of working capital is required.

(12) Business policy. If a business sets aside funds at the end of each year for the

depreciation, payment of loans and ploughing back of profits in the business, it requiresless amount of working capital. On the other hand, .a business which does not build its

own internal resources, needs larger amount of working capital to meet the day today

expenses of the business and other unexpected expenses.

Dinidend Policy

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