What it means
When a company issues preferred shares or certain kinds of debt, the terms may say that a portion must be redeemed (bought back and cancelled) each year. The mandatory redemption schedule lists the dates, the amounts or percentages, and the price.
Because the company has no choice, the schedule works like a loan repayment plan, even if the security is legally a share. Investors like the structure because the amount outstanding falls steadily and their capital comes back in stages.
A shrinking balance also reduces the risk that the issuer will be unable to find one very large payment at the end. Lenders and rating agencies look at the schedule to see how much cash the company must find each year.
Companies use schedules to match repayments with expected cash flow. A business with steady income from long contracts might agree to eight equal annual redemptions, while a growing business might choose a lighter schedule in early years and heavier payments later.
The schedule can also include a sinking fund, which is a pot of money set aside in advance to meet the payments. For accounting, the schedule matters because amounts that must be paid are generally treated as liabilities.
The portion due within twelve months is shown as a current liability, and the remainder as non-current. This presentation affects measures of liquidity such as the current ratio.
Failing to make a scheduled redemption is serious. It can trigger default, give the holders voting rights or block the company from paying dividends on its ordinary shares until the arrears are cleared.
Readers should check the exact consequences in the security's terms.
In practice
Real-world examples.
Example
A private equity-backed manufacturer issues preferred shares with a schedule that redeems 10% of the original amount each year from year four. The finance team builds the payments into its five-year cash forecast so that the redemptions never surprise the bank.
Example
A utility company issues bonds that require sinking fund payments every year. Investors accept a slightly lower yield because the schedule reduces the risk of a large payment at maturity.
Example
A shipping company agrees a redemption schedule with an investor that rises in step with its fleet income. The first two years carry small payments, and the later years carry larger ones, which suits the company as new vessels begin earning.
Formula
Calculation
Closing balance = Opening balance - Scheduled redemption
Cash outflow in the year = Scheduled redemption + Dividend on the opening balance
A company has $4,000,000 of redeemable preferred shares paying a 6% annual dividend, with eight equal annual redemptions of $4,000,000 / 8 = $500,000.
In year 1 the dividend is $4,000,000 x 0.06 = $240,000, so the cash outflow is $500,000 + $240,000 = $740,000, and the closing balance is $3,500,000. In year 2 the dividend is $3,500,000 x 0.06 = $210,000, the outflow is $710,000 and the closing balance is $3,000,000. In year 3 the dividend is $3,000,000 x 0.06 = $180,000, the outflow is $680,000 and the closing balance is $2,500,000.Case study
Seen in the real world.
Greenfield Packaging is an illustrative, fictional company that raised $6,000,000 by issuing redeemable preferred shares. The terms included a mandatory redemption schedule of $750,000 a year for eight years, starting at the end of year one.
In year three, a major customer left and cash flow tightened. The finance director reviewed the schedule and found that the annual redemption plus dividends consumed a large share of operating cash.
In this illustrative story, she opened talks with the investor early, before any payment was missed, and negotiated a short delay in return for a higher dividend. The lesson was that a fixed schedule rewards planning and punishes surprises.
Watch out
Common mistakes.
- Treating scheduled redemptions as optional, when the issuer is legally bound to make them on the dates stated.
- Forgetting that dividends or interest continue on the remaining balance, which means total cash outflow is higher than the redemption alone.
- Showing the whole balance as non-current when the part due within twelve months should be a current liability.
Questions
People also ask.
What is the difference between a mandatory redemption schedule and a call option?
A schedule obliges the issuer to repay on set dates, while a call option only gives the issuer the right to repay early.
Who benefits from the schedule?
Investors get their capital back gradually, and the issuer gains a structured plan, though it must keep enough cash available.
What happens if the company misses a payment?
The consequences are set in the terms and can include default, loss of dividend rights on other shares or voting rights for the holders.
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