The key determinant of dividend payments is the
current earnings which represents the capacity of a ?rm to pay dividends.
Pro?tability has a positive relationship with dividends. Research studies have
used Pro?t after tax (PAT), Return on Equity (ROE) and Return on net worth
(RONW) as proxies for pro?tability of the company.
• CASH FLOW
Brittain (1966) suggested that cash ? ow (net
current pro?t after tax + depreciation) is an appropriate measure of the
company’s capacity to pay dividend. Further the regulations and accounting
practices regarding depreciation allowance keep on changing and as such cash
?ow may be a better indicator of true earnings than net pro?t.
• LAGGED DIVIDEND
The speci?action of dividend equation by Lintner
(1956) suggested that lagged dividend is the only other explanatory variable of
dividend policy (?rst being net pro?t). The rationale of lagged dividend as a
determinant of dividend policy is provided by the speed of adjustment
mechanism, which states that companies try to achieve a certain desired payout
ratio in the long run. In order to follow a stable dividend policy management
has to allow the past dividend trend to in?uence the current dividend payments.
• DEBT EQUITY RATIO
The demand for external ?nance usually arises in a
company on account of constraints imposed by its internal resources. Higher the
internal Flows, given the investment requirements, lesser will be the demand
for borrowings and vice-versa. This implies, higher the dividend, larger the
demand for borrowings and higher is the debt equity ratio. Firms with high debt
ratios ought to pay lower dividends as they have already precommitted their
cash ?ows to make debt payments. Through lower dividend payout ?rm may avoid
borrowing more capital.
• SALES GROWTH
An increase in sales generates increased working
capital requirement, which in turn may adversely affect dividend payments. Some
research studies have also taken sales growth as proxy for growth and
investment opportunities available to ? rm. This signi?ces a negative
relationship between dividend and sales growth.
A ?rim may have adequate earnings to declare
dividends, but it may not have sufficient cash to pay the same. The liquidity
position of a company is expected to be positively related to dividend payment.
Current ratio and quick ratio has been used as proxy to measure liquidity
position of the company by various researchers.