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. How can the price of a stock change on the ex-dividend date?

    Find out more about dividend-paying stocks and how the prices of dividend-paying stocks are affected on the ex-dividend date, ...
  2. How is the ex-dividend date for a dividend on a stock determined?

    Review the important dates concerning dividend payments and learn how the ex-dividend date is determined when a company declares ...
  3. What is the average annual dividend yield of companies in the automotive sector?

    Learn about the average trailing annual dividend yield for companies in the automotive sector and what the dividend yield ...
  4. How can I find out the ex-dividend date for a stock's dividend?

    Learn about the various information sources from which investors can obtain information about upcoming ex-dividend dates ...
RELATED TERMS
  1. Tenured Capital

    Loans offered by the government to key business sectors.
  2. Fully Drawn Advance

    A type of long-term business loan used in Australia.
  3. Invoice Financing

    A way for businesses to borrow money based on amounts due from ...
  4. Record Date

    The cut-off date established by a company in order to determine ...
  5. Dividend

    A distribution of a portion of a company's earnings, decided ...
  6. Target Payout Ratio

    A target payout ratio is a measure of what size a company's dividends ...

You May Also Like

Related Articles
  1. Entrepreneurship

    How Microfinance and Investment Banking ...

  2. Charts & Patterns

    Are These the Top Dividend Stocks of ...

  3. Stock Analysis

    How Realty Income Became A Top Dividend ...

  4. Trading Strategies

    American Express: Headwinds and Tailwinds

  5. Stock Analysis

    Playing Small-Caps In This Market? The ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!