Factors Affecting Dividend Policy:
1. External Factors
2. Internal Factors
External Factors Affecting Dividend Policy
1. General State of Economy: * In case of uncertain economic and business conditions, the management may like to retain whole or large part of earnings to build up reserves to absorb future shocks. * In the period of depression the management may also retain a large part of its earnings to preserve the firm's liquidity position. * In periods of prosperity the management may not be liberal in dividend payments because of availability of larger profitable investment opportunities. * In periods of inflation, the management may retain large portion of earnings to finance replacement of obsolete machines.
2. State of Capital Market: * Favourable Market: liberal dividend policy. * Unfavourable market: Conservative dividend policy.
3. Legal Restrictions:
Companies Act has laid down various restrictions regarding the declaration of dividend: * Dividends can only be paid out of: * ** Current or past profits of the company. * Money provided by the State/ Central Government in pursuance of the guarantee given by the Government. * Payment of dividend out of capital is illegal. * A company cannot declare dividends unless: * ** It has provided for present as well as all arrears of depreciation. * Certain percentage of net profits has been transferred to the reserve of the company. * Past accumulated profits can be used for declaration of dividends only as per the rules framed by the Central Government
4. Contractual Restrictions:
Lenders sometimes may put restrictions on the dividend payments to protect their interests (especially when the firm is experiencing liquidity problems)
A loan agreement that the firm shall not declare any dividend so long as the liquidity ratio is less than 1:1.
The firm will not pay dividend more than 20% so long as it does