What is dividend policy? Explain the factors influencing the dividend policy of a company.

 Q. What is dividend policy? Explain the factors influencing the dividend policy of a company. 

Ans. MEANING OF DIVIDED POLICY:

Divided refers to that part of net profits of a company which is distributed among shareholders as a return on their investment in the company. 

A settled approach for the payment of dividend is known as dividend policy. Therefore, dividend policy means the broad approach according to which every year it is determined how much of the net profits are to be distributed as dividend and how much are to be retained in business. Thus, the dividend policy divide the net profits or earnings after taxes into two parts: 

(1) Earnings to be distributed as dividend 

(2) Earnings retained in business 

A firm will have to choose between the portion of profits distributed as dividends and the portion ploughed back into the business. The choice is called dividend policy and it will have its effect on both the long term financing and the wealth of shareholders. 

Factors influencing/determining/affecting the dividend policy.

The following are the factors which generally affect the dividend policy of a firm:

(1) Financial Needs of the Firm: Financial needs of a firm are directly related to the investment opportunities available to it. If a firm has abundant profitable investment opportunities, it will adopt a policy of distributing lower dividends. It would like to retain a large part of its earnings because it can reinvest them at a higher rate than the shareholders can. Other reason for retaining the earning is, that, issuing new share capital is inconvenient as well as involves flotation costs. On the other hand, if the firm has little or no investment opportunities, it should retain only a small portion of its earnings and distribute the rest as dividends.

(2) Stability of Dividends: Investors always prefer a stable dividend policy. They expect that they should get a fixed amount as dividends which should increase gradually over the years. Hence, while determining the dividend policy, the merits of stability of dividends like investor’s desire for current income, resolution of investor’s uncertainty, requirement of institutional investors etc. should be given due consideration.

(3) Legal Restrictions: The firm’s dividend policy has to be formulated within the legal provisions and restrictions. For instance, section 123 of the Indian Companies Act, 2013 provides that dividend shall be paid only out of current profits or past profits after providing for depreciation. Likewise, if there are past accumulated losses, they must be first set off against current year’s profits before the declaration of any dividend. Similarly, a firm is prohibited from declaring any dividends if its liabilities exceed its assests.

(4) Restrictions in Loan Agreements: Lenders, mostly the financial institutions, put certain restrictions on the payment of dividend to safeguard their interests. They may allow the payment of dividend only when some minimum amount has been transferred to sinking fund established for the redemption of their debt. Likewise, they may prohibited the payment of dividends in excess of certain percentage, say, 10%. Alternatively, they may fix the minimum limit of profits that may be used for dividend, say, not more than 40% of the net profits can be paid as dividends. When such restrictions are put, the company will have to keep a low dividend payout ratio.

(5) Liquidity: Payment of dividend causes sufficient outflow of cash. Although a firm may have adequate profits, it may not have enough cash to pay the dividends. It may happen when most of the sales are on credit and firm’s cash resources have been utilized in the expansion of assests or payment of its liabilities. This situation is common for growing firms which needs funds for their expanding activities and permanent working capital. Thus, the cash position is a significant factor in determining the size of dividends. Higher the cash and overall liquidity position of a firm, higher will be its ability to pay dividends. 

(6) Access to Capital Market: A company which is not sufficiently liquid can still pay dividends if it has esay accessibility to capital market. In other words, if a company is able to raise debt or equity in the capital market, it will be able to pay dividends even if its liquid position is not good. While evaluating the ability to raise funds in the capital market, the cost of funds and the promptness with which funds can be raised must be considered. Usually, mature firms have greater access to capital market than the new firms.

(7) Stability of Earnings: Stability of earnings has a significant effect on the dividend policy of a firm. Normally, the greater the stability of earnings, greater will be the dividend payout ratio. 

(8) Objective of Maintaining Control: Sometimes the present management employs dividend policy to retain control of the company in its own hands. When a company pays larger dividends, its liquidity position is adversely affected and it may have to issue new shares to raise funds to finance its investment opportunities. If the existing shareholders do not want or cannot purchase the new shares, their control over the company will be diluted. Under such circumstances, the management will declare lower dividends and earnings will be retained to finance the investment opportunities. 

(9) Effect on Earning per Share: As discussed above (5), high dividend payout ratio affects the liquidity position adversely and may necessitate the issue of new equity shares in the near future, causing an increase in the number of equity shares and ultimately the earning per share may reduce. On the other hand, by keeping a low dividend payout ratio the firm can retain and plough back larger portion of its earnings resulting in increase in future earnings and thereby an increase in earning per share.

(10) Firm’s Expected Rate of Return: If the firm’s expected rate of return would be less than the rate which could be earned by the shareholders themselves from external investment of their funds, then firm should retain smaller part of its earnings and should opt for a higher dividend payout ratio.

(11) Inflation: Inflation may also act as a constraint on paying larger dividends. Depreciation is charged on the original cost of the asset and as a result, when there is an imcrease in price level, funds generated from depreciation become inadequate to replace the obsolete assests. Consequently, companies will have to retain more of its earnings to provide funds to replace the assets and hence their dividend payout ratio will be low during periods of Inflation.

(12) General State of Economy: Earnings of a firm are subject to general economic conditions of the economy. If the future economic conditions are uncertain, it may lead to retention of larger part of the earnings of a firm to absorb any eventuality. Likewise, in the event of depression, when the level of level of business activity is very low, the management may reduce the dividend payout ratio to preserve its liquidity position.

All the above factors must be carefully considered before formulating a dividend policy.

Define Financial Management. Discuss the nature and functions of financial management.

 Q. Define Financial Management. Discuss the nature and functions of financial management.

Ans. MEANING OF FINANCIAL MANAGEMENT: The word ‘Financial Management’ is a combination of two words i.e Financial and Management. Financial meaning related to finance and management meaning making arrangements to get a job done in the most efficient and best possible manner. Thus, the combined meaning of financial management is to manage the finance related operations of a business enterprise in the best and most efficient manner. 

Financial management is that part of managerial process which is concerned with the planning and controlling of (financial resources of enterprise.) firm’s financial resources. It is concerned with the procurement of funds from most suitable sources and making the most efficient use of such funds. It deals with raising finance for the enterprise and the efficient utilisation of such finance. It includes investment decisions, financing decisions, dividend decisions, liquidity decisions, capital budgeting, budgetary control etc.

DEFINITION OF FINANCIAL MANAGEMENT: 

Financial Management or Finance function may be defined as:–

(1) “The finance function is the process of acquiring and utilising funds by a business.”

  — R.C. Osborn 

(2)  “Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.” 

— Joseph L. Massie

NATURE OR CHARACTERISTICS OF FINANCIAL MANAGEMENT: 

(1) An essential part of top management: Financial Management is an essential part of top management. In the traditional approach financial manager was considered to be an unimportant person as far as the top management decision making was considered. But in the modern business management the financial manager is one of the active members of top management team and day-by-day his role is becoming more significant in solving the complex management problems. This is because almost all kinds of business activities such as production, marketing etc. directly or indirectly involve the acquisition and use of finance.

(2) Less Descriptive and More Analytical: Modern financial management is less descriptive and more analytical. Due to the development of new statistical and accounting techniques of financial analysis, the financial management chooses the best alternative out of the many possible alternatives.

(3) Continuous Function: Financing is a continuous function. In addition to the raising of finance, there is a continuous need for planning and controlling the finances of an enterprise. A firm performs finance functions continuously in the normal course of the business.

(4) Different from Accounting Function: There are key differences between the accounting and finance function. Accounting generates information or data whereas in the finance function the data are analysed and used for the purpose of decision making.

(5) Wide Scope: There is wide scope of financial management. It is concerned not only with the raising of finance but also with the allocation and efficient use of such finance. It is also responsible for financial accounting, cost accounting, auditing, budgeting, management of cash, management of receivables and management of inventories.

(6) Centralised Nature: Financial management is centralised in nature. Whereas the production management, marketing management and personnel management functions can be decentralised, it is neither possible nor desirable to decentralise the financial responsibilities.

(7) Measurement of Performance: Financial management is concerned with the wise use of finance. It fixes certain norms and standards against which the benefits of an investment decision are matched. In other words, it matches the cost of finance with the return received from its use. Thus, it is concerned with the achievement of broad financial goals which an enterprise sets for itself.

(8) Inseparable Relationship between Finance and Other Activities: There exists an inseparable relationship between finance on the one hand and production, marketing and other activities on the other. All activities are related to finance. For example, buying a new machine or replacing an old machine is clearly a responsibility of the production department but it also involves finance. Similarly, recruitment of employees, advertisement, sales promotion all require financial resources.

(9) Applicable to All Types of Organisations: It is applicable to all forms of organisations whether corporate or non-corporate such as sole proprietorship and partnership firms etc. Similarly, it also applies to the concerns engaged in manufacturing or providing services and also the activities of non-profit organisations.

FUNCTIONS OF FINANCIAL MANAGEMENT: There are three basic functions of financial management, namely (i) raising finance, (ii) investing it in assets, and (iii) distributing returns earned from assets to shareholders. Theses three functions are respectively known as financing decision, investment decision, and dividend policy decision. Various other functions are also performed such working capital decision, planning and controlling the finance and certain routine functions. Hence, the functions of financial management are: 

(1) Determining the Financial needs: The first task of the financial management is to estimate and determine the financial requirements of the business. For this purpose, the short-term and long-term needs of the business are estimated separately. Financial needs are estimated with a long-term view so that necessary funds will be available for expansion and renewal of plant and machinery in future. While determining the financial needs the financial management should take into consideration the nature of the business, possibilities for future expansion, attitude of the management towards risk, general economic circumstances, etc.

(2) Financing Decision: This function is related to raising of finance from different sources. For this purpose the financial manager is to determine the proportion of debt and equity. In other words, what proportion of total funds will be raised from loans and what proportion will be provided by shareholders. The mixing of debt and equity is known as the firm's capital structure or leverage. Raising of funds through debts results in a higher return to the shareholders but it also increases risk. Hence, a proper balance will have to be ensured between debt and equity. A capital structure with a reasonable proportion of debt and equity capital is termed the optimum capital structure. When the return to shareholders is maximized with minimum risk, the per share market value of company's shares will be maximized and the firm's capital structure will be considered optimum. In order to raise the capital, a prospectus is issued and services of underwriters are used.

(3) Investment Decision: Investment decision also known as 'Capital Budgeting' is related to the selection of long-term assets or projects in whick investments will be made by the business. Long-term assets are the assets which would yield benefits over a period of time in future. Since the future benefits are difficult to measure and cannot be predicted with certainty, investment decisions involve risk. Investment decisions should, therefore, be evaluated in terms of both expected retum and risk. Further, a minimum required rate of return also known as cut-off rate is also determined against which the expected return from new investment can be compared.

(4) Working Capital Decision: It is concerned with the management of current assets. It is an important function of financial management since short-term survival of the firm is a pre-requisite for its long-term success. Current assets should be managed in such a way that the investment in current assets is neither inadequate nor unnecessary funds are locked up in current assets. If a firm does not have adequate working capital, that is its investment in current assets is inadequate, it may become illiquid and as a result may not be able to meet its current obligations and, thus, invite the risk of bankruptcy. On the other hand, if the investment in current assets is too large, the profitability of the firm will be adversely affected because idle current assets will not earn anything. Thus the financial management must develop a sound technique of managing current assets. It should properly estimate the current assets requirements of the firm and make sure that funds would be made available when needed.

(5) Dividend Policy Decision: The financial management has to decide as to which portion of the profits is to be distributed as dividend among shareholders and which portion is to be retained in the business. For this purpose the financial management should take into consideration the factors of dividend stability, bonus shares and cash dividends in practice. Usually, the profitable companies pay cash dividends regularly. Periodically, the bonus shares are also issued to the existing equity shareholders.

(6) Financial Control: The establishment and use of financial control devices is an important function of financial management. These devices include budgetary control, cost control, ratio analysis etc. In financial control, first of all standards of financial performance are determined. Thereafter, actual performance is compared with the predetermined standards and the deviations are ascertained. The reasons for such deviations are also found out so that steps are taken to remove those deviations.

(7) Routine Functions: For the effective execution of the finance functions, certain routine functions have to be performed in the normal course of the business The routine functions are:

(a) Supervision of cash receipts and payments and safeguarding of cash balance,

(b) Opening bank accounts and managing them.

(c) Safeguarding of securities, insurance policies and other valuable documents.

(d) Maintaining records and preparation of reports.

(e) Establishing a proper system of internal audit.

Define Financial Management. Discuss the nature and functions of financial management.