Posted: October 17th, 2013
Why is the cash position of a company important, when deciding to create a dividend policy?
Cashflows are a great determinant in the issuance of dividends to shareholders. The amount of cash within an entity enables the shareholders, creditors and other interested parties to evaluate the level of profitability of an entity with regard to the amounts of cash held by an entity (Lease, 2000). Cash reflects the amounts of liquidity within an entity which enables the entity to repay its debts and more so the dividends due to shareholders. High debts may make it impossible for an entity to pay dividends to its shareholders.
Dividend policies are determined by the presence of residual funds, which are used for the issue of dividends to shareholders. Hence, the amounts of cash that remains after the entities expenses, financial charges and corporation taxes are paid determine the amount of dividend to be issued to each individual (Lease, 2000). The amount of cash held by a company is important to the shareholder for various reasons because it influences the amounts of revenue accrued to their shares or capital contributions to the entity.
Dividends are not contractual rights of the shareholders requiring the organization to pay specific amounts of dividends to shareholders. In addition, the amounts of residual funds, which remain after issuance of dividends, are still party of the shareholders funds and are thus reinvested back into the entity. The amounts available for payment of dividends are important in the formulation of a dividend policy (Frankfurter, Wood & Wansley, 2003). This is because these amounts of funds could be used for the increasing the value of the shareholders’ capital held by the company. In addition, the company could also be influenced by inadequate amounts of cash by issuance of new shares in order to pay the existing shareholders the dividends due to them. Furthermore, the amounts of cash determine the dividend policy because higher dividends translate to higher taxes for the company and for the shareholders as well. In addition, dividends when not paid do not accrue taxes for the entity as well as for the shareholders. This has the potency to influence issuance or non-issuance of shares. The amounts of cash also influences the dividends policies in that it indicates the ability of the entity to pay the transactions involved in the issuance if the dividends and other related costs (Lease, 2000). Companies tend to have incentives on policies towards non-issuance of dividends because it enables an increase in the value of shares and thus the overall value of an entity due to the retained funds and the costs avoided such as interest, taxes and costs of issuing dividends (Da, Goergen & Renneboog, 2004).
Da, S. L. C., Goergen, M., & Renneboog, L. (2004). Dividend policy and corporate governance. Oxford: Oxford University Press.
Frankfurter, G. M., Wood, B. G., & Wansley, J. W. (2003). Dividend policy: Theory and practice. Amsterdam: Boston.
Lease, R. C. (2000). Dividend policy: Its impact on firm value. Boston, Mass: Harvard Business School Press.
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