Cumulative Preference Shares: Meaning, Types and Advantages

When companies need to raise money, they often issue different types of shares. One type is preference shares, which offer more safety than equity shares. Among these, cumulative preference shares are special because they allow unpaid dividends to be carried forward.

In this blog, we’ll explain cumulative preference shares in simple terms. You’ll learn how they work, their features, types, benefits, drawbacks, and how they compare with non-cumulative preference shares.

What are Cumulative Preference Shares?

Cumulative preference shares are shares that come with a fixed dividend. If the company can’t pay the dividend in a year due to low profits, the unpaid amount is not lost. Instead, it adds up and must be paid later when the company has enough profit.

This makes cumulative preference shares more reliable for investors who want steady income. These shares are also considered a safer option compared to equity because they are paid before common shareholders.

How Cumulative Preference Shares Work?

Let’s say a company issues cumulative preference shares with an 8% dividend on a face value of ₹100. If the company doesn’t pay dividends for two years, the unpaid amount (₹8 x 2 = ₹16) is carried forward.

In the third year, the company must first pay the ₹16 before paying any dividend to regular shareholders. This rule makes the shares attractive for those who want predictable returns.

This feature provides confidence to investors, especially during economic slowdowns. Even if dividends are missed, they are not lost forever. They simply build up and will be paid once the company becomes profitable again.

Features of Cumulative Preference Shares

• Fixed dividends: The rate is set in advance.

• Dividend carry forward: Unpaid dividends are added up for future payment.

• Priority over equity: These shareholders get paid before equity holders.

• Limited voting: They usually don’t vote unless their dividend is unpaid for a long time.

• Redemption option: Some shares can be bought back by the company after a set time.

• Less risk: Compared to equity, these shares offer a more stable income.

• No ownership control: Shareholders usually don’t influence company decisions.

Types of Cumulative Preference Shares

1. Convertible

These can turn into equity shares later. It allows investors to benefit from company growth if the share price increases.

2. Non-Convertible

These cannot become equity shares. They are for fixed income only and are preferred by conservative investors.

3. Participating

These shareholders can receive extra profits after getting their fixed dividend. This adds a bonus for those holding such shares.

4. Non-Participating

They only get the fixed dividend, with no share in extra profits. They are suitable for those who value income predictability.

5. Redeemable

These are repaid after a fixed period, offering a clear exit plan. This makes them useful for investors with specific time-bound goals.

Advantages of Cumulative Preference Shares

• Steady income: Dividends add up and are eventually paid.

• Lower risk: Safer than equity shares in terms of payments.

• Priority in payment: Paid before equity shareholders.

• Less market fluctuation: Prices don’t change as much as equity.

• Funding without control loss: Companies raise money without giving up voting power.

• Attracts cautious investors: They appeal to people looking for reliable income.

• Suitable during market volatility: They provide stability when stock prices fall.

Disadvantages of Cumulative Preference Shares

• No profit sharing: Investors don’t gain from rising profits.

• No regular vote: They don’t vote in most decisions.

• Dividend depends on profits: If the company makes no profit, payments are delayed.

• Inflation risk: Fixed returns may lose value over time.

• Payment after debts: In a company shutdown, debt holders are paid first.

• No price growth: Unlike equity shares, these do not offer capital appreciation.

Difference Between Cumulative and Non-Cumulative Preference Shares

Non-cumulative preference shares are riskier in this respect. If a company does not declare dividends in a given year, investors cannot claim them later. In contrast, cumulative shareholders can wait and receive unpaid dividends once the company earns enough.

Conclusion

Cumulative preference shares are a useful tool for both investors and companies. They offer a promise of eventual dividend payments and priority in income distribution. This makes them suitable for people looking for stable returns without taking too much risk.

Before investing, it’s important to know how these shares work and how they differ from non-cumulative preference shares. A clear understanding helps in making better financial choices. If you’re someone who values income stability and lower risk, these shares can be a suitable part of your investment strategy.

However, you must also be aware that they may not grow in value like equity shares. So, it is best to include them as part of a broader and balanced portfolio.