What it means
The preferred dividend is the income side of owning preference shares. It is defined in the share terms rather than decided each year, which is why investors think of it more like a coupon on a bond than a normal dividend.
Its position in the queue is what gives it weight. Nothing can be distributed to ordinary shareholders until the preferred dividend for the period, and any arrears from previous periods, has been settled in full.
For anyone reading a set of accounts, the practical effect shows up in earnings per share. Ordinary shareholders are entitled to profit after tax minus the preferred dividend, so a company with heavy preference capital can report healthy profits and thin earnings per share at the same time.
Boards still have discretion in most structures. A preferred dividend must be declared before it is payable, so a company under cash pressure can defer it, though on cumulative shares the deferral becomes an obligation that has to be cleared later.
The main variants change who benefits when results are good. Participating preferred dividends allow holders to take the fixed amount and then share in surplus distributions, while ordinary fixed preference terms leave all the upside with ordinary shareholders.
Cash planning is where the number bites hardest in a private company. The preferred dividend is a predictable annual call on cash that has to be funded before owners take anything out, so it belongs in the budget alongside loan repayments rather than being treated as a discretionary extra.
In practice
Real-world examples.
Example
A hotel group with $12,000,000 of 5% preference capital owes $600,000 in preferred dividends each year. In a weak season the board pays the preferred dividend in full and cancels the ordinary dividend entirely, which is exactly the priority the structure was designed to create.
Example
An engineering firm preparing its annual report deducts $240,000 of preferred dividends before calculating earnings per share. An analyst who forgets that step overstates the earnings figure available to ordinary investors.
Example
A start-up that raised money through participating preference shares is sold. The investors take their fixed preferred entitlement first and then share the remaining proceeds with the founders, which shrinks the founders' payout more than they expected. Modelling the split before signing the term sheet would have shown the effect clearly.
Formula
Calculation
Preferred dividend = Number of preference shares x Par value x Dividend rate
Earnings available to ordinary shareholders = Net income - Preferred dividend
Earnings per share = Earnings available to ordinary shareholders / Number of ordinary shares
A logistics company has 40,000 preference shares with a par value of $50 and a rate of 8%. The dividend per share is $50 x 8% = $4, so the total preferred dividend is 40,000 x $4 = $160,000 for the year.
The company reports net income of $2,160,000 and has 800,000 ordinary shares in issue. Earnings available to ordinary shareholders are $2,160,000 - $160,000 = $2,000,000, and earnings per share is $2,000,000 / 800,000 = $2.50. Had the preference shares never been issued, earnings per share would have been $2,160,000 / 800,000 = $2.70, so the preference capital costs ordinary holders 20 cents a share.Case study
Seen in the real world.
This illustrative and fictional case concerns Wrenfield Diagnostics, a laboratory testing business that funded a new site by issuing 30,000 cumulative preference shares at $100 par with a 7% rate. The annual preferred dividend was 30,000 x $100 x 7% = $210,000.
Two years later the fictional company reported net income of $1,410,000 with 600,000 ordinary shares in issue. Earnings available to ordinary shareholders were $1,410,000 - $210,000 = $1,200,000, giving earnings per share of $1,200,000 / 600,000 = $2.00.
The illustrative twist came when the board wanted to start an ordinary dividend after a strong year. It first had to clear a single skipped preference payment of $210,000 plus the current year charge, which delayed the ordinary dividend by two quarters and taught the management team to model the preference queue before promising anything to ordinary shareholders.
Watch out
Common mistakes.
- Forgetting to subtract the preferred dividend when calculating earnings per share. The result overstates what ordinary shareholders actually earned.
- Recording preferred dividends as an expense in the income statement. They are usually a distribution of profit, not a cost of doing business.
- Assuming a skipped payment simply disappears. On cumulative shares it becomes arrears that must be paid before ordinary dividends resume.
Questions
People also ask.
Can a company skip a preferred dividend?
Yes, if the board does not declare it, but on cumulative shares the amount still accrues and blocks ordinary distributions.
Is a preferred dividend the same as interest?
No; interest is a contractual obligation that is generally tax deductible, whereas a preferred dividend is a distribution and usually is not.
Where do I find it in the accounts?
Look in the statement of changes in equity and in the earnings per share note, where it is deducted from profit for the year.
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