For many firms, paying dividends is a matter of pride. Many companies have been paying dividends to their shareholders for decades. A dividend is a reward companies pay to their shareholders for investing in their equity. It is an amount paid out of the profits of the company to the shareholders at regular intervals.
The board of directors of the company decides an amount they wish to pay to the shareholders out of its profits. However, it is not mandatory for every firm to pay dividend.
dividend payout ratio
A dividend payout ratio is the ratio of total dividends paid by a firm to its net earnings for a specific period. It is basically the percentage of earnings which is paid to the shareholders as dividend.
For example, if the company’s dividend payout ratio is 20 percent. This implies that it has given 20 per cent of its total earnings as dividend to the shareholders while retaining the remaining 80 per cent.
The unpaid amount as dividend is used for corporate purposes like expansion, research and development, repayment of debt, operational investments etc. This amount is known as retained earnings.
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Calculation
A dividend payout ratio is calculated by dividing the total dividends paid during a specified time by the firm’s earnings during that period.
Dividend Payout Ratio = Dividend Payout / Net Income
For example, if a firm has paid 20 lakhs in dividends and net income in a quarter 1.2 crore in that period. Then the payout ratio would be 20,00,000/1,20,00,000 = 0/16 or 16.66 percent.
Another way to calculate the ratio is on a per-share basis. To do this, you divide the dividend per share by the earnings per share.
Dividend Payout Ratio = Dividend Per Share / Earnings Per Share
Earnings Per Share = Net Income / Total Shares Outstanding
For example, a firm has declared dividend of 2 per share and 20 lakh total outstanding shares. earnings have come out 1 crore.
Then first EPS = 1,00,00,000/20,00,000 = 5
and payout ratio = 2/5 = 0.4 or 40 percent
The payout ratio is 0 percent for firms that do not pay dividends and 100 percent for those that pay their entire net income in the form of dividends.
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