May 21, 2022

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PREFERENCE SHARES AND ITS ADVANTAGES

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PREFERENCE SHARES AND ITS ADVANTAGES

It is the shares, which have preferential right to get dividend and get back the initial investment at the time of winding up of the company. Preference shareholders are entitled to fixed rate of dividend and they can not  vote at the annual general meeting of the company.

Preference shares can be classified into the following types:

1. Cumulative preference shares:

Cumulative preference shares have right to claim dividends for those years the company do not have profits.

2. Non-cumulative preference shares:

Non-cumulative preference shares have no right to claim dividend any year the company fails to make profit.

3. Redeemable preference shares:

 This is a preference share that can be redeemed at a fixed maturity period. It can be redeemable during the lifetime of the company.

4. Irredeemable Preference Shares

Irredeemable preference shares can be redeemed only when the company liquidate. There is no fixed maturity period for such kind of preference shares.

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5. Participating Preference Shares

Participating preference sharesholders have right to participate extra profits after distributing to equity shareholders.

Non-Participating Preference Shares

Non-participating preference sharesholders are not having any right to participate extra profits after distributing to the equity shareholders.

Convertible Preference Shares

Convertible preference shares are shares that can be convert into equity shares after a specific period.

Non-convertible Preference Shares

There shares, cannot be converted into equity shares from preference shares.

Features of Preference Shares

The following are the important features of the preference shares:

1. Maturity period:

Preference shares have no fixed maturity period except in the case of redeemable preference shares. Preference shares can be redeemable only at the time of the company liquidation.

2.Residual claims on income:

Preferential sharesholders have a residual claim on income. Fixed rate of dividend is payable to the preference shareholders.

3.Residual claims on assets:

Preference is usually given to the preference shareholders at the time of liquidation. If any extra Assets are available that should be distributed to equity shareholder.

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4. Control of Management:

Preference shareholder does not have any voting rights. Hence, they cannot have control over the management of the company.

Advantages of Preference Shares

Preference shares have the following important advantages.

1. Fixed dividend:

The dividend rate of preference shares are fixed. It is called a fixed income security because it provides a constant rate of income to the investors.

2. Cumulative dividends:

Preference shareholders can received cumulative dividends. If the company does not earn any profit in any previous years, it can be cumulative with future period dividend.

3. Redemption:

Preference Shares can be redeemable after a specific period of time except in the case of irredeemable preference shares. There is a fixed maturity period for repayment of the initial investment.

4. Participation:

Participative preference sharesholders can in the surplus profit after distribution to the equity shareholders.

5. Convertibility:

Convertibility preference shares can be converted into equity shares when the articles of association provide such conversion.

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Disadvantages of Preference Shares

1. Expensive sources of finance:

Preference shares are quite expensive as a source of finance when compared to equity shares.

2.No voting right:

Generally, preference sharesholders do not have any voting rights. Hence they cannot have control over the management of the company.

3. Fixed dividend only:

Preference shares can get only fixed rate of dividend. They may not enjoy more profits of the company.

4. Permanent burden:

Cumulative preference shares is a permanent burden for the company insofar as the payment of dividend is concerned.

5. Taxation:

Unlike debenture and other interest bearing sources of finance, preference shares can not be used to reduce tax burden of a company.

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