What Are Non Cumulative Shares

Preference shares are an increasingly popular investment option among those looking for stability and the potential for dividend income in finance. Of all types of preference shares available, non-cumulative preference shares stand out for their unique qualities.

Companies issue shares to raise capital for expansion, growth, acquisition, and fund business operations. These shares can be primarily subdivided into common and preference share classes. Preference shares offer fixed dividends and payment priority over common shares. For non-cumulative preference shares, missed dividend payments do not accumulate. This article focuses on the meaning of non-cumulative preference shares, discussing insights on the advantages and disadvantages of these shares to understand if they are prudent investment avenues.
 

Also read: what is NSE

Non-cumulative preference shares are a type of preference shares that do not allow unpaid dividends to accumulate. Unlike cumulative preference shares, where missed dividends are carried forward to the next year, non-cumulative preference shares allow dividend payments in arrears. In other words, if a company does not declare a dividend in the present year, non-cumulative shareholders lose their right to claim it at a later stage.

Also read: what is BSE

Now that you understand the meaning of non-cumulative preference shares, it's time to debunk how these shares operate:

• Dividend priority
  Non-cumulative shares fall within the ambit of preference shares. Preference shareholders are entitled to a fixed dividend amount, regardless of the company’s performance in a given financial year. Additionally, preference shareholders receive their dividend payments before dividends are distributed to common shareholders. Non-cumulative preference shareholders are entitled to such fixed and prioritised dividend payments.

• Non-accumulation of dividends
  The absence of dividend accumulation differentiates non-cumulative preference shares from cumulative shares. If a company fails to issue dividends in a given financial year, non-cumulative shareholders cannot exercise a claim for these dividends when the company resumes payments. However, this right is available to cumulative shareholders.
   

Also read: What is SEBI

Investing in non-cumulative preference shares can be advantageous for both investors as well as the issuing company in the following ways:

• Higher dividends
  As a subset of preference shares, non-cumulative shares come with a fixed dividend rate, which is generally higher than cumulative preference shares. This compensates for the lack of dividend accumulation and makes non-cumulative shares more appealing to investors.

• Payment priority
  Non-cumulative preference shareholders enjoy payment priority over equity shareholders of a company. When a company announces dividend payments, non-cumulative preference shareholders are paid first and then the remaining sum is distributed among common shareholders. Additionally, non-cumulative preference shareholders also enjoy priority when it comes to claiming assets and funds during the company’s liquidation.

• Financial flexibility for the company
  Issuing non-cumulative preference shares is a cost-effective financing route for companies, especially during periods of economic downturns. Companies can skip dividend payments in a lean year without being obligated to pay them in the following year. This helps ease cash flow management pressures and lower long-term liabilities.

• Appealing to income-focused investors
  Investors seeking a relatively higher regular income find non-cumulative shares appealing. Investing in stable and financially sound companies lowers the possibility of missed dividend payments. Since non-cumulative preference shares usually pay a higher dividend than cumulative ones, they can offer a lucrative yield for investors with a high-income expectation and high-risk appetite.
   

Also read: Tick size

Despite these advantages, non-cumulative preference shares carry the following disadvantages:

• Risk of missed dividends
  The lack of the accumulation benefit makes non-cumulative preference shares inherently riskier than cumulative preference shares. If the company skips dividend payments in a year, non-cumulative shareholders cannot claim them in the future.

• Lack of stability
  Income-focused investors seeking a relatively stable flow of earnings may not find non-cumulative preference shares appealing. Since there are no legal obligations in place, companies can easily skip dividends in lean years without requiring to cover these payments in the latter years. In other words, dividend income can be highly unpredictable.

• Limited appeal
  Due to the risk of missed payments and lack of arrear coverage, these shares may have a limited appeal among investors. Companies often find it difficult to raise capital through non-cumulative preference shares because these shares are not attractive to investors seeking relatively stable returns.

• No voting rights
  Unlike common shares, preference shares do not offer voting rights to shareholders. In other words, non-cumulative preference shareholders cannot vote on crucial company matters that determine the direction of the company and can ultimately impact its financial health and earnings.

• Dependence on the financial health of the company
  While preference shareholders are entitled to a fixed dividend income, for non-cumulative shareholders this dividend income is not guaranteed. If the company registers a loss in a given financial year, it can skip dividend payments. In such cases, non-cumulative shareholders miss out their dividends since there is no accumulation benefit. Therefore, dividend income from non-cumulative shares depends on the company performing well.

Non-cumulative preference shares offer attractive advantages of a fixed dividend rate but also come with some significant disadvantages. While these shares offer potentially higher dividends and prioritised payments over common shares, they also carry the risk of losing dividend payments in the lean years. Given the lack of dividend accumulation, these shares are best suited for investors with a high-risk appetite who are willing to invest in stable companies for higher dividend income. The risky nature of non-cumulative preference shares makes them unsuitable for investors who prioritise dividend stability. At the end of the day, if you do decide to invest in non-cumulative preference shares, remember to carefully consider the financial health of the company and its historical track record of dividend payments to make an informed choice.