What is Non-Cumulative Preferred Stock?

Non-Cumulative Preferred Stock

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Non-Cumulative Preferred Stock

Non-cumulative preferred stock is a type of preferred stock that does not entitle the holder to claim unpaid or omitted dividends.

In a typical scenario, preferred shareholders have a higher claim on dividends than common shareholders. This means that the company must pay dividends to preferred shareholders before it can distribute earnings to common shareholders.

There are two types of preferred stocks: cumulative and non-cumulative. If the preferred stock is cumulative and the company can’t afford to pay a dividend one year, those unpaid dividends “accumulate” and must be paid out before any dividends on common shares in the future.

On the other hand, with non-cumulative preferred stock, if the company decides not to pay a dividend in a given year, those shareholders lose their dividend forever; the company is not obligated to make up for it in later years.

For example, consider a company that issues non-cumulative preferred stock with a $5 annual dividend. If the company decides not to pay dividends one year due to financial difficulties, the shareholders of the non-cumulative preferred stock will not receive that year’s $5 dividend and they will not be able to claim it in the future. If the stock were cumulative preferred stock, then the missed dividend would accumulate and the company would need to pay it in a future year before any dividends could be paid to common shareholders.

Example of Non-Cumulative Preferred Stock

Let’s consider a hypothetical company, FutureTech Inc. that has both non-cumulative preferred stock and common stock.

The non-cumulative preferred stock has a stated annual dividend of $5 per share.

In the first year, FutureTech Inc. has a profitable year, and thus it pays out the $5 dividend to the preferred stockholders, as promised. Then, it pays out dividends to common shareholders.

In the second year, however, the company faces some financial difficulties and decides not to pay dividends. For non-cumulative preferred stockholders, this means they will not receive their $5 dividend for that year. Unlike cumulative preferred stockholders, they do not have the right to claim this missed dividend in the future. This $5 dividend is lost and will not be paid out in subsequent years even if the company’s financial situation improves.

In the third year, if the company’s financial situation improves and it decides to resume paying dividends, non-cumulative preferred stockholders will receive their annual $5 dividend per share for that year. However, they won’t receive the missed $5 dividend from the second year.

So, the key aspect of non-cumulative preferred stock is that if a dividend is skipped or reduced, the impact is permanent and those missed dividends do not accumulate to be paid out in the future.

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