As the term implies, noncumulative preferred stocks can be defined as stocks whose dividends do not accumulate. All omitted dividend payments become automatically forfeited as they do not get paid arrears dividends in the future. Like all other preferred stock types, they come with a predetermined dividend rate which is usually a percentage of the par value or a specific dollar amount.
What are noncumulative preferred stocks?
Noncumulative preferred stock is a type of preferred stock whose dividends do not accumulate. Unlike cumulative preferred stockholders who receive previous dividends that were not paid which is known as dividends in arrears, all unpaid dividends for non-cumulative preferred are forfeited.
Holders of noncumulative preferred stock receive priority over holders of common stock when it comes to dividend payments as they get paid first along with other preferred stockholders before common stockholders get paid. However, since dividends for non-cumulative preferred stock do not accumulate if unpaid, it means that investors who own non-cumulative preferred stock in a company do not get paid dividends that were previously unpaid.
Non cumulative preferred stocks are also known as noncumulative preference shares or noncumulative preferreds.
Features of non cumulative preferred stock
- Fixed dividend payment.
- No payment of dividends in arrears.
- Preference during dividend payment.
- Claim on assets in cases of bankruptcy or liquidation.
The noncumulative preferred stock features are the characteristics that differentiate this type of stock from other stock types. Below, we will have a brief look at these features.
Fixed dividend payment
Non-cumulative preferred shares have a fixed amount of dividend that is paid to their holders either quarterly or annually. The dividend amount is usually a percentage of the stock par value or a specified dollar amount and is usually predetermined and indicated in the stock prospectus.
No payment of dividends in arrears
Once dividends for a particular quarter or annum are skipped, the company is not obligated to pay the non cumulative shareholders dividends in arrears. This means that the shareholders forfeit all unpaid dividends automatically.
Preference during dividend payment
Noncumulative preferred stockholders receive preference when dividends are paid. They receive dividends before common stockholders.
Claim on assets in cases of bankruptcy or liquidation
In a situation whereby the issuing company goes bankrupt or liquidates, non-cumulative preferred shareholders have a claim on the assets along with the company’s bondholders, creditors, and all other types of preferred shareholders.
Pros and cons of non cumulative stock
Everything that has advantages also has some disadvantages, this is also true for non cumulative stock. We will have a look at some of the pros and cons of noncumulative shares both to the companies that issue them and the investors who purchase these stocks below.
Non cumulative preferred stock pros for the companies
- Reduction of expenses.
- Predetermined dividends.
- Retention of control.
- Source of funds.
Companies issue stocks primarily as a means of raising funds either for business expansion or other related operations, in addition to that, there are other additional benefits of issuing non-cumulative preferred stock. Let’s have a look.
Reduction of expenses
Companies are not obligated to pay investors who have purchased non-cumulative stock dividends in arrears. Therefore, if the company is experiencing a financial crisis in a particular quarter or year, it can choose to skip dividend payments without any penalty. Furthermore, the issuing company has a reduction in expenses in quarters or years when they do not pay dividends and can use such funds for other operational needs of the business.
Predetermined dividends
Dividends paid to non cumulative stockholders are already predetermined. This means that even in years when the company makes extra profits, it can use it for other operational expenses and not dividend payments.
Retention of control
Considering that non cumulative shareholders do not have voting rights, companies that issue such stocks retain control over their companies since they are still the only ones who can vote on issues of acquisitions, mergers, purchases, and electing its board members.
Source of funds
The issuing of noncumulative stocks is a source of raising capital for the purchase of tangible assets or intangible assets, expansions, and other business operations that require such funds.
Non cumulative preferred stock pros for the investors
- Affordable.
- Preference during dividend payments.
- Priority claim on assets during bankruptcy or liquidation
Investors primarily invest in stocks for the benefits they derive from such investments. We have stated the pros of owning non cumulative preferred stock above and we will have a brief look at each below.
Affordable
Compared to other types of preferred stocks, the noncumulative preferred stock is sold at a relatively affordable rate thereby making it an attractive investment option.
Preference during dividend payments
Non-cumulative shareholders receive preference during dividend payments along with other preferred stock types ahead of holders of common shares.
Priority claim on assets during bankruptcy or liquidation
Unlike shareholders who own common shares that do not have a claim on assets during liquidation or bankruptcy, people who own non cumulative preferred stocks have a claim on the issuing company’s assets.
Cons of non cumulative preferred stock
- Dividends do not accumulate over time
- No voting rights
- No increase in dividends
As listed above, we will discuss some cons of purchasing non cumulative preferred stock below:
Dividends do not accumulate over time
The fact that dividends for non cumulative preferred shares do not accumulate over time makes it a big demerit to the investor. This is because the issuing company could choose to skip dividends payment since they know they have no obligation to pay dividends in arrears.
No voting rights
Holders of non cumulative stocks have no say in the company in which they own shares since they have no voting rights and consequently, cannot vote on any matter in the company.
No increase in dividends
The dividends for non cumulative stocks are predetermined, therefore, there is no increase in dividends even in years or quarters when the issuing company makes an excess profit.
Non cumulative stock dividends formula
- Annual noncumulative preferred stock dividend formula
- Quarterly noncumulative preferred stock dividend formula
The non-cumulative preferred stock dividends formula is a financial metric through which an investor can calculate how much dividends they get paid. Depending on the terms of dividend payments, they can be paid either annually or quarterly.
Annual noncumulative preferred stock dividend formula
The dividend formula for annual payment is expressed as Annual non cumulative preferred stock dividends = Par value x Dividend rate x Number of stocks owned
Quarterly non cumulative preferred stock dividend formula
The dividend formula for quarterly payments is expressed as Quarterly non cumulative preferred stock dividends = Annual dividends ÷ 4
Non cumulative preferred stock calculation
The noncumulative preferred dividends formulas have little importance on their own unless they get put to use in a calculation. Therefore, we will use them below for some examples in calculating annual and quarterly dividend payments.
Example one
Assuming a fast food company wants to open a new outlet but does not have enough funds for the expansion and decides to issue one million (1,000,000) preferred shares of which one hundred thousand (100,000) are non cumulative preferred stocks. If Mr. X buys five thousand (5,000) non cumulative stocks at a par value of fifty dollars ($50) with a dividend rate of seven percent (7%), how much dividends will he be paid annually?
Using the annual dividends formula, we can calculate how much dividends Mr. X will receive as follows:
Annual non cumulative preferred stock dividends = Par value x Dividend rate x Number of stocks owned
Par value = $50
Dividend rate = 7% ÷ 100 = 0.07
Number of stocks owned = 5,000
Annual non cumulative preferred stock dividends = $50 x 0.07 x 5,000
Annual non cumulative preferred stock dividends = $17,500
This means that Mr. X is expected to receive $17,500 in dividends annually.
Example 2
Assuming a car manufacturing company issued non cumulative shares with a face value of thirty dollars ($30) and a dividend rate of fifteen percent (15%). If Miss. B purchases ten thousand (10,000) stocks, how much will she be paid quarterly as dividends?
We can calculate the dividends, Miss. B will receive quarterly using:
Quarterly non cumulative preferred stock dividends = Annual dividends ÷ 4
To ascertain the quarterly dividends, we need to first calculate the annual dividends.
Annual non cumulative preferred stock dividends = Par value x Dividend rate x Number of stocks owned
Par value = face value = $30
Dividend rate = 15% ÷ 100 =
Number of stocks = 10,000
Annual non cumulative preferred stock dividends = $30 x 0.15 x 10,000
Annual non cumulative preferred stock dividends = $45,000
However, since it is the quarterly dividend payment we want to find out, we can do so as follows:
Quarterly non cumulative preferred stock dividends = $45,000 ÷ 4
Quarterly non cumulative preferred stock dividends = $11,250
This means that Miss. B will receive $11,250 quarterly as her non cumulative dividends payment.
FAQs on non cumulative stock
What is the formula for calculating non cumulative preferred stock dividends?
The non cumulative preferred dividends are paid either annually or quarterly and can be calculated using:
Annual non cumulative preferred stock dividends = Par value x Dividend rate x Number of stocks owned
Quarterly non cumulative preferred stock dividends = Annual dividends ÷ 4
What are the features of non cumulative stocks?
Non cumulative stocks have the following characteristics:
1. They have a fixed dividend amount.
2. Dividends are not paid in arrears.
3. They receive preference during dividend payment.
4. They have claims on assets in cases of bankruptcy or liquidation
Conclusion
We have looked at non cumulative stock definition, features, dividends formula, and some examples. This gave an overview of what they are and how they function. One of the key features of non cumulative stocks is that their dividends do not accumulate over time. We have also seen that what is considered a pro for the issuing company might be considered a con for the investor, it is, therefore, important for both businesses and investors to look keenly at the options and weigh their merits or demerits before issuing or purchasing non cumulative stocks.
Last Updated on November 2, 2023 by Nansel Nanzip Bongdap
Blessing's experience lies in business, finance, literature, and marketing. She enjoys writing or editing in these fields, reflecting her experiences and expertise in all the content that she writes.
