A:

In short, the stronger the company's internal cash flow, and in turn cash position, the less the need to draw on an external fund. If internal cash flow or the retention ratio increases, external fund requirements would decrease. If internal cash flow suffers, external fund requirements will climb.

Specifically, if a company reduces its payout ratio, it means that it is retaining more money in shareholders' equity, which can be used, in turn, to meet funding needs. With all other things remaining equal, such as internal liabilities, this reduced dividend payout ratio would lower the external fund requirement.

Conversely, a decline in profit margin, assuming overall revenue stays the same, would translate into less internal cash. This would increase the overall funding need and raise the external fund requirement.

Often these two actions are counterbalanced. Companies not wanting to increase their external fund requirements will often decrease their payout ratio in response to long-term declines in profit margin. Of course, a move such as this can raise shareholder fears and frustrations, putting a downward pressure on the overall price of a stock.

For more, see Is Your Dividend At Risk? and The Importance Of Dividends.

This question was answered by Ken Clark.

RELATED FAQS
  1. What is the difference between external economies and external diseconomies?

    Learn to differentiate between external economies and external diseconomies, as well as between external economies and diseconomies ... Read Answer >>
  2. What is the difference between cash flow and fund flow?

    See how cash flow and fund flow differ from each other, and why fund flow can be used very differently by accountants and ... Read Answer >>
  3. For what types of investments is the payout ratio the most relevant?

    Find out about the payout ratio, what the payout ratio measures and the type of investment that the payout ratio is used ... Read Answer >>
  4. Are taxes calculated in operating cash flow?

    Learn how taxes are involved with the calculations for operating cash flow, and find out about the importance of operational ... Read Answer >>
  5. Who developed the theory of economic externality?

    Discover which economist developed the theory of economic externalities, and learn how and why some advocate for taxation ... Read Answer >>
  6. Are dividend payout ratios different in different economic sectors?

    Discover which economic sectors have traditionally higher or lower dividend payout ratios and the various factors that determine ... Read Answer >>
Related Articles
  1. Investing

    Corporate Dividend Payouts And the Retention Ratio

    An investor can use dividend payout and retention ratios to gauge an investment’s possible return, and compare it to other stocks.
  2. Investing

    Payout Ratio vs. Retention Ratio: When to Use Which

    The payback ratio and retention ratio collect different information and are useful in different situations.
  3. Investing

    Lessons On Corporate Dividend Payout And Retention Ratio

    Why are dividend payout and retention ratios important to consider when investing in company stock? What companies have high ratios?What constitutes a high dividend payout and retention ratio? ...
  4. Investing

    Dividend Ratios: Payout And Retention

    The dividend payout ratio and retention ratio measure how much profit a company gives back to shareholders as dividends. When a business earns money, it must decide whether to use all of its ...
  5. Investing

    Evaluating A Statement Of Cash Flows

    The metrics for the Statement of Cash Flows is best viewed over time.
  6. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  7. Investing

    A Guide For Calculating The Dividend Payout Ratio

    Dividends are a significant contributor to total equity returns. That makes dividend payout ratios—which are key indicators of dividend sustainability—doubly important.
  8. Investing

    The Essentials Of Corporate Cash Flow

    Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself.
  9. Small Business

    Understanding Externality

    An externality is a consequence of an economic activity that is experienced by unrelated third parties.
RELATED TERMS
  1. Dividend Payout Ratio

    The percentage of earnings paid to shareholders in dividends. ...
  2. External Economies Of Scale

    The lowering of a firm's costs due to external factors. External ...
  3. Cash Flow From Financing Activities

    A category in the cash flow statement that accounts for external ...
  4. Production Externality

    Costs of production that must ultimately be paid by someone other ...
  5. Cash Flow Statement

    One of the quarterly financial reports any publicly traded company ...
  6. Free Cash Flow Yield

    An overall return evaluation ratio of a stock, which standardizes ...
Hot Definitions
  1. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  2. Down Round

    A round of financing where investors purchase stock from a company at a lower valuation than the valuation placed upon the ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  5. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  6. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
Trading Center