What are Cumulative Preference Shares?
Equity shares refer to the shares that a company issues to the public. These shares can be bought and sold on the stock exchanges, and you can own as many or as little of these as per your preference and investment budget.
However, there is another type of share that a company may issue to the public with the main aim of raising capital. These special shares are known as preference shares. And although they do not provide the shareholders with any voting rights, they do offer dividends.
Preference shares are further divided into various types. One of these is cumulative preference shares. Let us find out more about cumulative preference shares meaning with example, so you can get a clear idea.
What are Cumulative Preference Shares?
Cumulative preference shares offer an extra advantage over other types of preference shares. These shareholders are given preference for the payment of dividends. As you may know, companies pay dividends to shareholders from time to time. However, many a time, companies may not earn enough profits to be able to reward their shareholders. As a result, they may not pay any dividends to the shareholders. Sometimes, they may only pay a limited or reduced amount of dividend.
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In either of these cases, the culumative preference shareholders get precedence over others when receiving dividends. If the company pays reduced dividends or pays dividends after a long absence, the first preference is always given to these shareholders. This is how preference shares differ from equity shares. This is because equity shareholders have no such right to receive the dividend.
Now that you know what is cumulative preference share, here is a cumulative preference shares example to help you understand better.
Let’s take the example of Company A. Company A issued cumulative preference shares of ₹200 each. The dividend announced on this share was 10%, i.e., ₹20 per share. Now, every quarter, the company pays ₹20 per share to all shareholders as dividends. However, due to some economic turbulence, the company could not pay the shareholders any dividends for 2 quarters. This implies that two dividends of ₹20 + ₹20 = ₹40 were not paid to the shareholders.
In quarter 3, the company finally earned a profit and decided to pay the shareholders. In this case, going by the cumulative preference shares definition, the company would first clear all the dues of these shareholders before it would pay anyone else. So, the cumulative preference shareholders would receive the arrears of ₹40 before any other shareholder, including equity shareholders. Once they all receive their dues, the company will use the remaining profits to issue the dividend for the 3rd quarter to other shareholders.
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Who should Invest in Cumulative Preference Shares?
Cumulative preference shares are ideal for investors with a low-risk appetite. Since the dividend payments for these shares are always prioritized, they offer a kind of surety to investors. Equity shares may be risker in comparison as there is no guarantee of receiving any dividends. However, it is important to understand that cumulative shareholders do not have any voting rights as equity shareholders. They also do not have any management rights.
But cumulative preference shareholders enjoy greater dividends than equity shareholders. Moreover, the unpaid dividends are always paid in the end. They may be delayed but are never unpaid.
Now that you know the cumulative preference shares meaning, let’s move on to some frequently asked questions.
Also Read: What are Equity Shares?
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Frequently Asked Questions
Cumulative preference stocks may offer higher dividends than equity shares. Moreover, they carry lower risk as the dividends are assured. This can be a great advantage for shareholders as their earnings are secure and always guaranteed.
If you are looking for guaranteed dividends, cumulative preference stocks can be a good choice for you. These stocks pay all arrears of dividends and give preference to shareholders at the time of dividend payment.
Cumulative preference stocks are stocks that offer an advantage to shareholders at the time of payment of dividends. If the company has suffered a loss due to which it could not pay enough dividend to the shareholders, or if the company has paid no dividends to the shareholders for a few quarters, the cumulative preference shareholders will be the first ones to receive their payment when the company finally earns a profit and is able to pay the dividend.
Preference shares can be of different types, such as cumulative, non-cumulative, convertible, non-convertible, participatory, and non-participatory.