Page 83 - Microsoft Word - 00 P1 IW Prelims.docx

The dividend decision

2.2 Dividend signalling

Investors read signals into the company's dividend decision and that
these signals say as much about the company's future financial
performance as they say about its past financial performance.

Thus management will not necessarily reduce the dividend per share
just because last year's performance was poor, if they believe that next
year's performance will be good.

2.3 The cash needs of the entity

Investment, financing and dividend decisions are all interlinked.

Therefore, it is important to also consider the impact of investment and financing
when considering dividend policy. Different types of business will have very different
cash needs and will therefore have to set their dividend, investment and financing
policies accordingly.

Examples

 Company with a poor credit rating – might struggle to raise finance from
external sources, so its cash needs might have to be met by restricting the
amount of dividends it pays out.

 Growing company – many potential investment opportunities, which will have to
be met by balancing dividend policy alongside external finance sources.

 Well-established, stable company – might be cash rich, so might be able to
afford to pay out large dividends without compromising its internal cash needs.

71