Question

dividend payment linked to profits left out after meeting the expansion needs is based on ....theory policy?

Answer 1

Dividend payment linked to profits left out after meeting the expansion needs is based on Residual dividend policy theory.

• Residual dividend policy theory is a policy where profits are used to fund new projects with the remaining profits being distributed as dividends. So dividends are only paid when earnings are not exhausted by the company’s financial requirements and there are no profitable investment projects to left invest in.This policy is suitable when the  company wants to invest more in order to grow the future profits.

However, there are other dividend policy theories used by companies which include:

• Constant payout ratio - in this policy the company’s management maintains a fixed percentage dividend payout ratio irregardless of profits earned during the year.  For example if a company payout ratio is 60% then it means that the company will distribute 60% of its earnings as dividends .This policy is suitable when the company wants to maintain a constant part of the earnings for more investment and growth the company. This policy is suitable when the company wants to maintain a constant part of the earnings in order to use for investment and growth of the company.

• Low constant dividend per share plus surplus or bonus policy - in this policy the dividend per share is set very low and is paid for each period and only extra dividends will be paid during periods of high earnings. However this extra dividend is paid in such a way that does not imply any commitment on the part of the company to continue paying the any extra dividend in the future. This policy is suitable when the company’s profit highly fluctuates.

• Stable/Fixed dividend per share policy – This is where the management maintains a fixed dividend per share each year. The company pays out a fixed amount of the dividend per share irrespective of earnings made during the year. Therefore the shareholders are treated as if they were preference shareholders. Since the dividend per share is stable, the share price increases. This policy is appropriate when the company is making constant or growing profits and the cash flow of the company is strong.

Answer 2

Answer: Residual Dividend policy theory.  

This policy is used when the profits obtained are used for funding or financing new projects and the residual of the profit is used to distribute as dividends.

Dividends are paid if there is some residual of earnings left after funding the new projects and the financial and capital requirements of the company has been completely taken care of by the earnings.

When organisations wants to grow more and also wants to invest in more projects, this policy helps the way out to achieve their goals.

This policy is more linked to the profits left after meeting the organisational needs.