October 19, 2020

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Meaning of Cumulative Preference Shares with Key Explanations

Meaning of Cumulative Preference Shares with Key Explanations
Shares

A company may issue preference shares. When this happens, there may be an additional clause. This clause(s) make the preference shares be given different names such as participating and non-participating preferred stock, convertible and non-convertible preference shares. In this lesson, a special type of these shares will be discussed; cumulative preference shares.

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What is cumulative preference shares?

A type of shares that gives the holder a right to the cumulative dividend in the event of which the company cannot pay a dividend in the present or past periods.

It can also be defined as a type of preference shares, in the case of unpaid dividends, will receive all arrears of dividend before ordinary shares will receive the dividend.

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Key Explanations

It is a type of shares. Cumulative preferred shares are a type of shares. But not any type of it. It falls within the structure of preference shares.

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Right to the cumulative dividend. These shares give it holder a right. That right is the privilege to receive a cumulative return on their investment. The holders of this type of shares received an accumulation of past dividends.

A company may not pay dividends to shareholders because of the current economic situation. In such a case, cumulative preference shareholders will have their dividend accumulated for as many periods the company is unable to pay such dividends.

As soon as there is an economic boom for the company, it will pay-up all the accumulated dividends to them first before paying any other shareholders, especially ordinary shares.

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Cumulative preference shares can be understood if you understand the meaning of accumulating. This means to sum up. Therefore, the dividends of this type of shares will be sum up to when the company is able to pay them.

Then, they are paid their dividends before other shareholders. Also, ordinary shareholders will receive dividends after every other shareholder have been paid.

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An Example

This can be understood better with an example. Assuming ANC has a 10% cumulative preference shares at N1 each valued as 1 million Naira in 2018. This means that the company will pay 100,000 Naira dividend every year (10 ÷ 100 × 1,000,000). It also has ordinary shares worth 5 million Naira.

It has successfully pay up dividend for 2018 and 2019. However, because of the current COVID-19 pandemic, the company makes a loss and therefore couldn’t declare any dividend in 2020. What this means is that the company will not pay a dividend to all shareholders no matter their rank.

In 2021 however, the company bounce back and earn good profits. Base on the agreement, the cumulative preference shareholders will be paid their arrears of dividend for last year, that’s 100,000 Naira and the 2021 dividend of 100,000 Naira. This is a total of 200,000 Naira dividends.

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However, ordinary shareholders will receive only a current dividend. The rate of the dividend, of course, is determined by the board of directors of the company.

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Conclusion

To conclude, cumulative preference shares are all about dividends received by the shareholders. In the case of any other events, such as liquidation, the holders are on the same rank as other preference shareholders.

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