Dividend Payout Policy

The cash flows earned by the firm at the end of a trading period are the property of its shareholders after the current debt has been serviced. There is a constant tension between management and ownership on whether these cash flows should be paid out as dividends or retained by the firm.

There are several market based views on whether dividends should be paid out or retained depending on the circumstances of the firm and the projects that it has.  In any case growth is a function of the amount of money ploughed back into the business (and additional capital raised) defined by:

Growth (%) = Return on equity (%)  X Plough back ratio (%)

Where the plough back ratio is the ratio between cash flow retained versus the cash flow paid out to the shareholders

There are several dividend payout models in use. The three most popularly used models are;

1. The constant growth model (also called the Gordon Growth Model) which postulates that dividends are grown at a constant rate. The difficulty with this model is that firstly companies cannot constantly keep growing their dividends in perpetuity and secondly in conditions where the cost of capital is high the growth rate is higher than the discount rate;
2. The zero growth model which has a constant pay out of a set dividend. Consequently as companies grow the amount being retained increases and should increase the capital gain of the company. These models work for high growth companies and mature companies;
3. Several hybrid models with a combination of payout and retention strategies 

Key benefits of providing for a planned dividend decision by smaller SME’s are:

1. Capital funding for growth is planned for and made available at critical moments (ergo the company is not loaded with debt and unable to raise and more funds when funds when they are most needed);
2. Retention of earnings are based on a plan that creates capital growth that is planned and not accidental;
3. That the right amount of dividends are paid out or shares repurchased when cash surpluses are built up in any one year.