Non-cumulative (Stock) - Explained
What is a noncumulative Stock?
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Table of ContentsWhat is Noncumulative Stock?How is Noncumulative Stock Used?How Noncumulative Preferred Stock WorksWhy are noncumulative Preferred Shares Important?Helps in managing the companys cash flow The company has no payment obligation High level of protection Preference rights during liquidation The cons of Noncumulative Preferred StockAcademic Research on Noncumulative Stock
What is Noncumulative Stock?
Noncumulative is a term used to describe a type of preferred stock that permits the issuing firm not to pay dividends to its stockholders. It means that the stockholders have no right to claim any omitted or unpaid dividends. The opposite of this is a cumulative preferred stock where any pending accumulated dividends must be paid to the stockholders. In this case, the stockholders have all the rights to claim for any pending accumulated dividends from the issuing company.
- Noncumulative is a term used to describe a type of preferred stock that permits the issuing firm not to pay dividends to its stockholders.
- If the issuing company skips paying noncumulative preferred stockholders dividends, the common stock shareholders will not get either.
- Noncumulative preferred stock does not accumulate in arrears, and its holders have no right to claim it in the future. Also, the company has no obligation of making any skipped dividends payments.
- When it comes to dividend or liquidation payment, the noncumulative preferred stockholders have preference over the holders of the common stock.
How is Noncumulative Stock Used?
Basically, noncumulative preferred stock is where dividends do not accumulate in arrears. It means that if at any given year the holders of this stock were not paid dividends, they should not expect payment of the same in the future. Skipping dividend payment may happen when the issuing company is not able to achieve the set financial benchmarks. As a rule, preferred shareholders are always the companys priority during dividend payment. If a company feels that it has earned enough and it can pay its shareholders some dividends, the first consideration is always the holders of preferred stock. In this case, only the holders of preferred stock receive payment since dividends are guaranteed each year. Holders of common and noncumulative stocks, their dividend payment depends on the financial performance of the year. Keep in mind that if the issuing company skips paying noncumulative preferred stockholders dividends, the common stock shareholders will not get either. It means that both will miss out on the dividends if the issuing company was not able to meet its financial target that particular financial year.
How Noncumulative Preferred Stock Works
For instance, lets assume that Company XYZ is not able to pay dividends to its noncumulative preferred shareholder this year. The shareholders have no right to claim for the missed dividends in the future years. Also, the company has no obligation of paying the skipped dividends to the holders of noncumulative preferred stock in the future. However, in the case of cumulative preferred shareholders, the company has an obligation of ensuring that such shareholders receive all their pending dividends. The same shareholders have a right to claim any pending dividend payment the issuing company owes them. it means that cumulative preferred shares are important that the noncumulative preferred shares. It is the reason why they are given priority when it comes to the dividend payment.
Why are noncumulative Preferred Shares Important?
Helps in managing the companys cash flow
Noncumulative preferred shareholders offer a company a greater opportunity to manage its cash flow. If the company feels that by paying the dividends, it will affect the cash flow, it will skip the payment to ensure that the cash flow is not affected. And it can skip dividends payments without incurring any penalties.
The company has no payment obligation
The company has no obligation to make dividend payments to the holders of noncumulative preferred stocks. The company is free to skip dividend payments without accumulating arrears for payment in the future. Since this type of preferred stock does not accumulate dividends, its holders have no right to claim for dividend payment. The company is the one to decide whether it is in a position to pay them dividends.
High level of protection
With noncumulative preferred stock, the shareholders enjoy a certain level of protection. For instance, they have the assurance that no common stockholder can receive dividends before them. It means that they have priority over the holders of the common stock. The preference over the common stock makes a noncumulative preferred stock more attractive.
Preference rights during liquidation
When it comes to a company liquidation, the holders of noncumulative preferred shares also have preferential rights. For instance, when the company liquidates, they are entitled to receive payment first before the common stockholders.
The cons of Noncumulative Preferred Stock
Generally, noncumulative preferred stock is not common in the stock market. The reason is that most investors don't prefer it because it puts them in a state of uncertainty where they have no assurance of income flow. Also, this issuance of dividends when it comes to this type of stock is at the discretion of the company's board of directors. So, only a few companies offer this kind of shares since investors rarely buy them unless the discount offer is attractive.
Academic Research on Noncumulative Stock