A company when it earns a profit or some surplus amount remains, uses it by re-investing the funds into the company which is known as ‘retained earnings’ and some fraction of it is usually distributed as dividend.
The word ‘dividend’ comes from the Latin word ‘dividendum’ (‘thing to be divided’). Whenever a company makes a profit, it distributes some portion of it as a dividend to its shareholders. A company when it earns a profit or some surplus amount remains, uses it by re-investing the funds into the company which is known as ‘retained earnings’ and some fraction of it is usually distributed as dividend.
A company can issue two types of shares under the Companies Act, 2013,
With voting rights, or,
With differential rights as to dividend, voting or otherwise in accordance with such rules and subject to such conditions as may be prescribed
As one can understand from the very name itself, this kind of share gets some preference over other kinds of share, i.e. equity share. Preference shares, commonly referred to as preferred stock, are shares of a company's stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company becomes bankrupt, preferred stockholders are entitled to be paid from company assets before common stockholders. Preference shareholders generally, also do not hold any voting rights, but common stockholders do have voting rights in general. Equity shareholders of a common stockholder, as we might address them, are only paid when the preference shareholders or preferred stockholders are paid in full.
During the lifetime of the company, they are assured of a preferential dividend. The preferential dividend may consist of a fixed amount (say one lac rupees) payable to the preference shareholders before anything is paid to the equity shareholders. Alternatively, the amount payable as a preferential dividend may be calculated at a fixed rate, e.g. 10% of the nominal value of each share.
When a company goes into liquidation, i.e. when a company is in the process of winding up, the preference shareholders carry a preferential right to be paid from the assets or guarantees of the company. Amount paid upon preference shares must be paid back before any amount is paid to the equity shareholders.
Different Kinds of Preference Shareholders Paid Differently
A cumulative preference share confers a right on its holder to claim fixed dividend of the past year(s) and current year out of future profits. A preference shareholder is entitled to a dividend every year. It may be possible that a company doesn’t have the money to pay dividends on preference shares in a particular year. The dividend is then added to the next year’s dividend. If the company can’t pay it the next year as well, the dividend keeps getting added until the company can pay. These are known as cumulative preference shares.
The non-cumulative preference share gives the right to its holder to a fixed amount or a fixed percentage of dividends out of the profits each year. Suppose no profits are available in any year, the shareholders right to dividend lapses for that particular year. He gets nothing nor can they claim unpaid dividend in any subsequent year.
Generally, preference shares are cumulative unless expressly stated to be non-cumulative.
Participating preference shares are those shares which are entitled to a fixed preferential dividend and also carry a right to participate in the surplus profits, along with equity shareholders, after dividend at a certain rate has been paid to equity shareholders. Similarly, at the time of winding up, if after paying back both the preference and equity shareholders, there is any surplus left, then the participating shareholders get an additional share in the surplus assets of the company along with the equity shareholders.
This kind of shares is those who are eligible to get only the fixed amount or a fixed percentage of dividends and nothing else. They don’t get any share of surplus profits. And also, they don’t receive a share in the surplus assets of the company at the time of winding-up of the company.
According to section 123(1)(a) of the Companies Act, 2013, the dividend can be paid out of the following.
Profit of the current year after providing of the depreciation; or
Profit of the previous financial year or years after providing for depreciation for previous years; or
Out of the money provided by Central or State Government for payment of dividend in pursuance of guarantee given by that, if any.
Notice of dividend shall be given to the persons who are eligible to have a share in it as per Table F of Schedule I of the Companies Act, 2013.
i. Companies in a Board Meeting may decide the amount of dividend which they want to recommend in the General Meeting.
ii. Company will mention the resolution for Dividend in the Notice of General Meeting.
Ordinary resolution for declaration of a dividend will be passed.
Once a dividend is declared, it must be paid within 30 days.
Dividends declared in the General Meeting can’t exceed the dividend recommended by the Board.
Dividends declared in General Meeting by a member can be less than the dividend recommended by the Board.
Dividend paid in the General Meeting is the Final Dividend.
The basic reason for investing in a company is to earn profits by having a share in the profit of the company. From the above discussion, we can sum up by saying that having a preferential share in a company has its share of advantages and disadvantages. Getting a fixed amount of dividend every time is a positive sign. However, they cannot earn the extra profits that an equity shareholder can earn, but the latter scenario is somewhat risky. So, it can be said that it is a personal choice depending upon one's financial background and risk-taking mentality to choose between preferential share and equity share.
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