What it means
Preferred shares pay a fixed dividend, usually set as a percentage of the share's face value. They rank ahead of ordinary shares for dividends, but the board must declare each payment.
Whether a missed payment is owed later depends on whether the shares are cumulative or non-cumulative. With cumulative preferred shares, skipped dividends build up as arrears, and the company must pay them before paying anything to ordinary shareholders.
With non-cumulative shares, there is no such build-up. If the board does not declare a dividend in a given year, the right to that year's payment disappears.
For investors, this means more risk. A struggling company can skip dividends for several years and owe nothing for the missed periods when it recovers.
Because of this, non-cumulative shares usually pay a higher dividend rate than comparable cumulative shares, to compensate. There is still some protection.
Most non-cumulative preferred shares carry a restriction that the company cannot pay ordinary dividends in any period in which it has not paid the preferred dividend. That ranking keeps the preferred holders ahead of ordinary shareholders, even though they cannot claim arrears.
For issuers, non-cumulative shares offer flexibility and, in some industries, regulatory benefits. Banks, for example, often issue them because regulators can treat them as stronger capital, since the bank can skip a payment without default.
A manager planning a capital raise should compare the investor appeal and cost of each type. When reading a company's financial statements, check the terms in the notes on share capital.
They will state whether preferred dividends are cumulative and what happens when payments are missed. That small detail can have a large effect on the value of the shares.
In practice
Real-world examples.
Example
A bank issues non-cumulative preferred shares to strengthen its capital. When profits fall in a bad year, the board skips the dividend. Holders receive nothing for that year and cannot claim it later. Analysts see the decision as a sign of stress but not a default.
Example
An investor compares two preferred shares from similar companies, one cumulative at 5% and the other non-cumulative at 6%. She chooses the non-cumulative shares because the extra 1% outweighs the loss of protection for her. She keeps an eye on the company's earnings. She understands that if a dividend is skipped, she cannot recover it later.
Example
A manufacturing company in difficulty skips its preferred dividend for two years. Holders of non-cumulative shares lose both payments. When profits return, the company pays only the current year's dividend before paying ordinary shareholders. Their loss shows why the feature carries a higher yield.
Formula
Calculation
Annual preferred dividend = number of shares x par value x dividend rate
A company has 10,000 non-cumulative preferred shares with a $100 par value and a 5% dividend rate. Annual dividend = 10,000 x 100 x 0.05 = $50,000. If the company pays nothing in year 1 and resumes in year 2, it owes only the $50,000 for year 2, and the missed $50,000 for year 1 is lost.Case study
Seen in the real world.
Redstone Foods is a fictional company that issued 20,000 non-cumulative preferred shares with a $50 par value and a 6% dividend. In this illustrative story, the annual dividend was 20,000 x 50 x 0.06 = $60,000. A poor harvest led the board to skip the dividend in one year.
Investors were upset, but the company had no obligation to pay arrears. When trading recovered, it paid the normal $60,000 the following year, and holders received nothing for the missed year. The board later added a promise not to pay ordinary dividends until preferred holders had received a full year's payment, to reassure the market.
Redstone's finance director later explained at the shareholder meeting why the shares had been issued in this form. The non-cumulative terms let the company skip a payment when cash was short without building up a debt, and the 6% rate was meant to reward investors for accepting that risk. She added that the board would still treat the dividend as a priority whenever profits allowed.
Watch out
Common mistakes.
- Assuming missed dividends will be paid later. With non-cumulative shares they are lost.
- Ignoring the yield difference. Non-cumulative shares should pay more to compensate for the added risk.
- Confusing skipped dividends with default. The board has discretion, so skipping a non-cumulative dividend is not a default. Holders cannot sue for the missing payment as they could for unpaid interest on a bond.
Questions
People also ask.
What is the difference between cumulative and non-cumulative?
Cumulative shares accumulate unpaid dividends as arrears, while non-cumulative shares do not. The distinction decides whether a skipped payment is a delay or a permanent loss.
Why would a company issue non-cumulative shares?
They give the board flexibility and, for banks, can count as stronger regulatory capital.
Do non-cumulative holders rank ahead of ordinary shareholders?
Yes, for dividends and usually in liquidation, but they have no right to arrears.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related