The Dividend Coverage Ratio (DCR) is a simple way to figure out how many times a company can use its net income to pay payments to its owners. This is also known as dividend cover, and it lets buyers figure out how likely it is that they won’t get rewards. DCR is also helpful for companies to figure out if they can keep paying returns now and in the future.
If a company has a high DCR, it generally means that it can keep paying dividends at the same rate. A high DCR also shows that a company is keeping enough of its income after all required adjustments have been made. By putting these gains back into the business, cash flow can go up even more, which means dividends can go up in the future.
A low DCR, on the other hand, could mean that a company is taking out loans to pay profits. It shows that the company may not be making as much money as it used to or isn’t keeping enough money to put back into the business. Because of this, directors often try to get and keep a high DCR.
DCR formula
Even though there are some differences, this is the general method for figuring out DCR:
DCR = net income/dividend paid
In this method, net income is the amount of money left over after all costs and bills have been taken out of the total income. The number of payouts that owners are due is what is meant by “dividend declared.”
Investors can change this method to figure out how many times a company can pay dividends to its owners if it also has to pay dividends to its favored shareholders. This second method has the following steps:
DCR = (net income minus the number of preferred dividends that must be paid) / dividends paid to common owners.
How does DCR look in real life?
In general, a DCR of 2 is considered good because it shows that a company has enough money to pay its earnings twice. A DCR of less than 1.5 is seen as a possible worry because it shows that loans are being used. It’s also important to know that some companies may decide not to pay dividends at all and instead raise the market value of their shares as a way to thank their owners.
Here is an example of how DCR works:
A company makes $1 million a year and must pay $100,000 to its favored shareholders every year. In the past year, it also gave $300,000 in profits to its common shareholders. In this case, the method we would use to figure out the DCR would be:
(£1,000,000 net income - £100,000 preferred dividend payments) / £300,000 dividends to common owners = DCR of 3:1.
Is there something wrong with the percentage of dividends to earnings?
DCR is a useful measure that lets buyers check how long a company can keep paying dividends. There are, however, some problems with the number that should be thought about.
The method uses net income, but cash flow does not always equal net income. Even though a business may show a high net income, it may not have enough cash on hand to pay dividends.
Different industries have different DCR standards, so there is no one “ideal” amount of DCR. Since net income can change a lot from year to year, using past financial records to figure out DCR isn’t always the best way to do it.
