Part I. Financial Statements and Ratio Analysis and Forecasting
2.7: Interest Paid on Bonds and Dividends Paid on Stock
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From Introduction to Financial Analysis by LibreTexts (Kenneth S. Bigel, Touro University), used under the CC BY 4.0 licence. Written for a general audience, not for NEPSE.
- Only a fter interest is paid on the corporation’s debt, may preferred dividends then be paid. If the dividend is not paid, it is not consid ered a “default” as with a loan or debt; this is because preferred stock represents ownershi p interests and not a liability. Preferred stock is thus thought of as a hybrid debt/equity security as it has characteristics of both .
- Most preferred shares are “cumulative,” which means that before any dividends are paid to common shareholders, all those preferred dividends that have not been paid, and are thus said to have accumulated unpaid or “in arrears , ” must first be paid 2 .
- However, as common shareholders have rights to “ residual ” profits (i.e., after interest is paid on debt and, second, after preferred stock dividend distributions) that the firm ma y generate , common shareholders also have the most opportunity to share in positive earnings growth , i.e., they have the most to gain .
- As a result, c ommon shares usually come with “voting rights,” i.e., the ability annually to vote for company management and on certain key issues. Notably preferred shares rarely carry such rights.
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