An omitted dividend is a dividend that a company’s board of directors has decided not to pay. Typically, a corporation that has issued preferred shares has an obligation to pay dividends to its preferred shareholders before it makes any dividend payments to common shareholders. If a company is unable to make this payment or chooses not to for any reason, it’s known as an “omitted dividend.”
In many cases, preferred shares have a “cumulative” feature, which means that any unpaid (omitted) dividends are accumulated and must be paid in full before any dividends can be paid to common shareholders. These unpaid dividends are referred to as “dividends in arrears.” Not all preferred shares have this feature, however; it depends on the specific terms of the security.
The omission of a dividend can be a red flag to investors, particularly for those who rely on dividend income or view regular dividends as a sign of a company’s financial health. Therefore, companies usually consider very carefully before deciding to omit a dividend.
Example of an Omitted Dividend
Suppose a company named “TechVentures Inc.” has issued cumulative preferred stock with an annual dividend of $5 per share. The company has been facing financial difficulties and has decided to suspend dividend payments this year in order to conserve cash.
In this case, the $5 per share that was not paid out to preferred stockholders is considered an “omitted dividend.” Because the preferred shares are cumulative, TechVentures Inc. will need to make up for this omission in the future when its financial condition improves. The unpaid amount becomes dividends in arrears.
Now, let’s say that next year TechVentures Inc.’s financial situation improves and the board of directors decides to resume dividend payments. Before any dividends can be paid to common shareholders, the company must first pay the current year’s preferred dividends plus the $5 per share omitted dividend from the previous year. Only then can the company consider paying dividends to its common shareholders.
This example illustrates how an omitted dividend works with cumulative preferred shares. The omission signifies a short-term suspension of dividends, not a cancellation. The company is obligated to pay these dividends at a later date before any dividends can be paid to common shareholders.