Non-Cumulative Preference Shares: Meaning and Example

Non-cumulative preference Shares do not cumulate dividends, as the name suggests. For example, XYZ Corporation issues preference shares with a 4% annual dividend. If XYZ skips dividend payments in a year, these dividends don't accumulate, and shareholders won't receive them in the future. 

Non-Cumulative Preference Shares are types of preference shares which are traded in the stock market. Preference shares are a type of stock that typically provides dividends before common shares and often have a fixed dividend rate. But in case of non-cumulative preference shares, omitted or non-paid dividend shares are not paid, unlike cumulative preference shares. 

Table of Content

• What are Non-Cumulative Preference Shares?
• Example of Cumulative Preference Shares
• Advantages of Non-Cumulative Preference Shares
• Disadvantages of Non-Cumulative Preference Shares

What are Non-Cumulative Preference Shares?

Non-cumulative preference shares are a type of preference share where the dividend is not accumulated if it's not paid out. Unlike cumulative preference shares, where unpaid dividends are carried over to the next year, non-cumulative preference shareholders lose the right to claim dividends that are not declared in a given year. 

In other words, if a company decides not to pay dividends in a particular year, non-cumulative preference shareholders cannot claim those dividends in the future. This makes non-cumulative preference shares a riskier investment compared to their cumulative counterparts, especially in companies with fluctuating profits.

Example of Cumulative Preference Shares

Imagine "Sunrise Technologies" issues non-cumulative preference shares with a 4% annual dividend. Jane, an investor, buys these shares. In its first year, the company faces a setback and skips the dividend payment. Unlike cumulative shares, Jane's missed 4% dividend doesn't accumulate. The next year, Sunrise recovers and resumes dividends, but Jane only receives that year's 4%, not the previous year's missed payment. This exemplifies the non-cumulative nature of these shares.

Advantages of Non-Cumulative Preference Shares

Higher Dividend Rates: To compensate for the lack of dividend accumulation, non-cumulative preference shares often have higher dividend rates than cumulative preference shares. This can provide a more attractive yield for investors in stable companies.

Appeal to Income-Focused Investors: These shares particularly appeal to investors looking for a higher regular income. In a financially stable company, a higher dividend yield can offer a lucrative return.

Cost-Effective for Companies: Non-cumulative preference shares can be advantageous for the issuing company during financial downturns. If the company is unable to pay dividends in a particular year, it is not obligated to make up for those missed payments in the future, thereby easing cash flow pressures.

Priority over Common Shares: Like all preference shares, non-cumulative shares have priority over common shares regarding dividend payments and liquidation proceedings. This means that even without the cumulative feature, these shareholders get paid before common shareholders.

Convertible and Callable Options: Non-cumulative preference shares can include features like convertibility to common stock and callability (the company’s right to buy back shares), providing flexibility for both the investor and the company. The conversion option can be particularly attractive in a rising market, while the callable feature can benefit the company by reducing its cost of capital.

Disadvantages of Non-Cumulative Preference Shares

Risk of Missed Dividends: The primary disadvantage is the risk of missing dividends. If a company decides not to pay dividends in a given year, non-cumulative preference shareholders cannot claim these dividends in the future. This makes them riskier than cumulative preference shares, where unpaid dividends accumulate.

No Voting Rights: Like most preference shares, non-cumulative preference shares usually do not provide voting rights. This means shareholders have no say in company decisions, including those that could impact the company's financial health and dividend-paying ability.

Lower Priority in Liquidation: In case of liquidation, preference shareholders are paid after debt holders, including bondholders and creditors. This means that in a financial crisis, there might be little left for preference shareholders after settling debts.

Limited Capital Appreciation: Non-cumulative preference shares typically offer limited potential for capital appreciation compared to common shares. Their value is more stable, which means they don't benefit as much from the company's growth.

Dependence on the Company's Financial Health: The dividend payment on non-cumulative preference shares depends on the company’s profitability and financial decisions. If the company faces financial hardships or decides to reinvest profits instead of paying dividends, shareholders may not receive the expected returns.

Conclusion!!

Non-cumulative preference shares offer a unique investment avenue, blending aspects of equity and fixed-income securities. While they provide higher dividend rates and priority over common shares in dividend payments and liquidation, they come with the notable risk of lost dividends in non-paying years, and no voting rights. 

Ideal for investors seeking higher regular income from stable companies, these shares demand careful consideration of their financial health and dividend-paying history to mitigate risks inherent in their non-cumulative nature.