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What is Non-Cumulative Preference Shares: Meaning & Example

When a company wants to grow or expand its business, it needs funds. One common way to raise this capital is by offering securities, like equity shares or preference shares, to the public, institutions, or other investors. Among these, preference shares have gained popularity, particularly among those seeking stable returns through dividend payments.

Within the world of preference shares, non-cumulative preference shares are distinguished by their unique features.

Understanding Non-Cumulative Preference Shares

Non-cumulative preference shares are a type of stocks that gives investors a fixed dividend, if the company chooses to declare it. However, if the company doesn’t pay dividends in a particular year, investors lose the right to receive that missed payment later on. This is what sets them apart from cumulative preference shares, where missed dividends are carried forward and paid before any dividends are given to common shareholders.

In simple terms, non-cumulative preference shareholders only receive dividends for the years when they are actually declared. If a company skips paying dividends in a given year, there’s no way to claim that amount in the future, even if the company’s profits improve.

This makes non-cumulative preference shares a bit riskier, especially in companies with unpredictable or uneven earnings.

Key Features of Non-Cumulative Preference Shares

Non-cumulative preference shares function similarly to other preference shares. However, they have some distinct features. These are:

  1. Priority in Payment of Dividends

    If the company makes a decision to pay dividends, non-cumulative preference shareholders are paid first before common shareholders. They receive a fixed rate, provided that the dividend is declared.

  2. No Carry Forward of Missed Dividends

    If the company fails to declare a dividend in any one year, that forfeited dividend is lost forever. The shareholders can't call for it later, as opposed to cumulative preference shares, where unpaid dividends are carried forward until they are paid out.

Example of Cumulative Preference Shares

Suppose a company issues 2,000 non-cumulative preference shares of ₹100 each bearing a 7% fixed dividend. So, every year, the shareholders should receive ₹7 per share, or a total of ₹14,000.

If the company distributes dividends for the initial three years, investors will receive ₹14,000 annually. But let us assume that in the fourth year, the company does not make any dividend payments, say, because of financial problems, shareholders do not get their due. And they will not be able to claim the ₹14,000 they lost subsequently, even if the company again runs into profits.

Only the dividends declared in a given year are paid out, nothing more, nothing less.

Advantages and Disadvantages of Non-Cumulative Preference Shares

Advantages

Let us first take a look at the advantages of Non-Cumulative Preference Shares:

1. Greater Flexibility for Companies

One of the key perks is that companies aren't required to pay back missed dividends in future years. This helps businesses preserve cash during tough times, manage expenses more effectively, and maintain financial stability without the pressure of overdue payments piling up.

2. Lower Financial Obligation

Since unpaid dividends don’t accumulate, companies avoid long-term dividend liabilities. This reduces their burden and supports smarter financial planning, especially during years of low profit.

3. Fixed Dividends When Declared

When the company does declare dividends, non-cumulative preference shareholders receive a fixed dividend rate. This provides some predictability and can be attractive to those seeking occasional but steady returns in profitable years.

4. Higher Dividend Rates & Payment Priority

These shares often come with higher dividend rates than common equity shares. Additionally, in the event of dividend distribution or liquidation, non-cumulative preference shareholders are prioritised over regular shareholders.

5. Attractive to Risk-Tolerant Investors

Investors who are willing to take on a bit of risk in exchange for the potential of higher returns may find these shares suitable, especially in businesses that are generally profitable but experience occasional fluctuations.

Disadvantages 

While they offer some flexibility and potential rewards, non-cumulative preference shares also come with a fair share of drawbacks. Here are the disadvantages of Non-Cumulative Preference Shares:

1. No Right to Missed Dividends

If the company doesn’t declare a dividend in any given year, that amount is lost forever. Investors have no right to claim it later, making it a riskier choice compared to cumulative preference shares.

2. Unpredictable Returns

Because dividends aren't guaranteed and don’t carry forward, the income from these shares can be irregular. This can be frustrating for investors who rely on consistent dividend payouts.

3. Less Security for Conservative Investors

For those who prefer safety and guaranteed income, non-cumulative preference shares might not be the right fit. The lack of assured payments makes them less appealing than cumulative alternatives.

4. Higher Risk During Economic Downturns

In tough financial years, companies may decide not to declare dividends at all. This puts investors at greater risk, as there’s no fallback or accumulation of missed payments.

Difference Between Cumulative vs Non-Cumulative Preference Shares

The main difference between cumulative and non-cumulative preference shares lies in how unpaid dividends are handled. With cumulative preference shares, if the company skips dividend payments, those missed payments are added up and paid later. In contrast, non-cumulative preference shares don’t work that way; if the company doesn’t declare a dividend in a given year, that amount is simply lost and can’t be claimed in the future.

The table below clearly shows the difference between cumulative and non-cumulative preference shares. Take a look:

Feature

Cumulative Preference Shares

Non-Cumulative Preference Shares

Unpaid Dividends

Carried forward and paid in future years

Not carried forward; once missed, they’re gone

Investor Risk

Safer, since you still get unpaid dividends later

Riskier, as missed dividends are permanently lost

Dividend Payment

Paid every year, even if delayed, once the company becomes profitable

Paid only for the years when dividends are actually declared

Company’s Flexibility

Less flexible, has to repay skipped dividends eventually

More flexible, no obligation to pay dividends not declared

Investor Appeal

More attractive due to stable and guaranteed returns

Less attractive because of the possibility of lost income

Conclusion

Non-cumulative preference shares offer a compelling middle ground between equity and fixed-income investments. With higher dividend rates and payment priority over common shareholders, they appeal to investors looking for potentially greater returns, especially from financially stable companies.

However, a major trade-off lies in their non-cumulative nature: missed dividends in unprofitable years are lost forever. Unlike cumulative preference shares, there's no provision for recovery later, which introduces a level of risk for income-focused investors.

Still, for those willing to accept that risk, non-cumulative preference shares can be rewarding, offering rather high dividend rates among all share classes. The key lies in selecting companies with a strong history of regular dividend payouts and sound financial health.

Disclaimer: This article is for informational purposes only and does not constitute investment advice. Bajaj Broking Financial Services Ltd. (BFSL) makes no recommendations to buy or sell securities.

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