What Is a Residual Dividend?

A residual dividend is a dividend policy used by companies whereby the amount of dividends paid to shareholders amounts to what profits are left over after the company has paid for its 澳洲幸运5官方开奖结果体彩网:capital expenditures (CapEx) and 澳洲幸运5官方开奖结果体彩网:working capital costs.

Companies that use a residual dividend policy fund CapEx with available earnings before paying 澳洲幸运5官方开奖结果体彩网:dividends to shareholders. This means the dollar amount of dividends paid to 🦹investors each year will vary. 

How a Residual Dividend Works

A residual dividend policy means companies use earnings to pay for CapEx first. Dividends are then p🌜aid with any remaining earnings generated.

A company’s 澳洲幸运5官方开奖结果体彩网:capital structure typically includes both long-term debt and equity. CapEx can be financed with a loan (debt) or by issu꧟ing more stock (equity).

Special Considerations 

While shareholders may accept management’s strategy of using earnings to pay for CapEx, the investment community analyzes how well the firm uses asset spending to generate more income. The return on asset (ROA) formula▨ is net income divided by total assets, an🦩d ROA is a common tool used to assess management’s performance. 

If a clothing manufacturer's decision to spend $100,000 on CapEx is the right one, the company can increase production or operate machinery at a lower cost, and both of these factors can increase profits. As 澳洲幸运5官方开奖结果体彩网:net income increas♐es the ROA ratio improves, and shareholders may be more 💟willing to accept the residual dividend policy in the future.

𝕴 However, if the firm generates lower earnings and continues to fund CapEx at the same rate, shareholder dividends decline.

Requirements for a Residual Dividend 

When a business generates earnings, the firm can either retain the earnings for use in the company or pay the earnings as a dividend to stockholders. 澳洲幸运5官方开奖结果体彩网:Retained earnings are used to fund current business operations or to buy assets. Every company needs assets to operate, and those assets may need to b🌄e upgraded over time and eventually replaced. Business managers must consider the assets required to operate the business and💝 the need to reward shareholders by paying dividends.

For the residual dividend policy to work, it assumes the 澳洲幸运5官方开奖结果体彩网:dividend irrelevance theory is true. The theory suggests that investors are indifferent to which form of return they receive from a company—whether it be dividends or 澳洲幸运5官方开奖结果体彩网:capital gains. Under this theory, the reꦫsidual dividend policy does not affect the company’s market value since investors value dividends and capital gains equally. 

The calculation for residual dividends is done p🎃assively. Companies using retained earnꦗings to finance CapEx tend to use the residual policy. The dividends for investors are generally inconsistent and unpredictable. 

Example of Residual Dividends

A clothing manufacturer maintains a list of capital expenditures that are required in fu🌳ture years. In the current month, the firm needs $100,000 to upgrade machinery and buy a new piece of equipment.

The firm generates 🎶$140,000 in earnings for the month and spends $10🌞0,000 on CapEx. The remaining income of $40,000 is paid as a residual dividend to shareholders, which is $20,000 less than was paid in each of the last three months.

Shareholders might be disappointed when management chooses to lower the dividend payment, and senior management must explain the rationale behind ♍💎the capital spending to justify the lower payment.