Preferred stock offers shareholders the benefit of receiving their dividend payments before the company pays any dividends to the owners of common shares. When the board of directors meets, it determines the total dividend amount to be paid. The company calculates the amount to pay to preferred shareholders first. The remaining amount goes to the common shareholders. The company needs to determine whether the preferred stock is cumulative or noncumulative in order to calculate the dividend amount.
Cumulative preferred stock refers to shares of stock where the dividends accumulate each year unless the company pays them annually. The corporation determines whether or not to pay dividends. If the company chooses not to pay dividends one year, the company considers those dividends to be in arrears. The company must pay the current year's dividend and any dividends in arrears before paying anything to the common shareholders.
Each share of preferred stock includes a par value and a dividend rate. The par value represents an arbitrary value that the company assigns to the stock. This value holds no relationship to the selling price of the stock. The dividend rate refers to the amount of dividend to be paid, and can be stated as a dollar amount or as a percent of par. The company calculates the dividend to be paid by multiplying the par value times the dividend percent. This calculates the dividend rate per share. The company multiplies the dividend per share by the total number of preferred shares outstanding to determine the annual dividend amount to pay the preferred stockholders. The company then adds the number of years the dividends are in arrears to the current year. The company multiplies this number by the annual dividend payment.
Noncumulative preferred stock refers to shares of preferred stock that has the dividends start over each year. If the company chooses not to pay dividends one year, the dividends do not go into arrears. The company only needs to pay dividends for the current year before paying the remaining amount to the common shareholders.
The company only needs to calculate one year's dividend for the preferred shareholders. The company multiplies the preferred stock dividend rate by the number of shares outstanding to determine the preferred dividend to be paid.