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Introduction to this document

Dividend calculator

Dividends are often declared in private companies because it’s tax-efficient for the owner-directors to be remunerated this way. However, there are times when you may need to justify the amount paid.

Funding requirement

Dividend versus salary is a longstanding part of tax planning in owner-managed private companies. But while dividends are often the preferable option, there are times when you may need to justify the level paid. For example, you may need to account for dividend levels to the company’s bank manager when applying for more funding or to shareholders who are not owner-managers.

 

The first thing to remember is that dividends are only one way that shareholders benefit financially. They can also benefit from an increase in the value of the company, and it’s all about getting the right balance between the two.

 

In broad terms you either fund your company out of retained earnings or obtain funds by borrowing from outside the company. This net funding requirement means that some of your dividends need to be retained to provide working capital. Our Dividend Calculator allows you to make an adjustment for funding in calculating how much profit is available for dividends.

Cost of equity

Instead of simply increasing the company’s borrowings, the owner-manager should consider taking lower dividends, as this will mean higher retained earnings which can then be used to finance some of the company’s growth. This is a sensible way to reduce the level of risk in the business and the overall cost of capital whilst still benefiting the shareholders with capital growth.

You could set the dividends payable to shareholders that match with the cost of equity for companies in your industry. Calculate this by adding the rate of return on government securities to the risk premium. Our dividend calculator gives you the facility to do this.

Maximum

The amount of dividend that can be paid can’t be more than the company’s retained profits on the latest available balance sheet. If in doubt, you should ask your accountants or auditors to confirm whether your company is in a position to declare the required dividends. Your cash flow forecast will then tell you whether any dividends declared can actually be paid.

As an additional rule of thumb, divide the amount of dividend by the post-tax profits for the year. If the answer is more than one, then the company is paying out more in the year than it earned!