Preferred stock is a reliable funding source for a corporation or company. It is a class of stocks that does not provide voting rights. It is comparatively safer than common stocks. Preferred stocks holders are prioritized before other common stockholders during the dividend payment. The two types of preferred stocks are cumulative preferred stocks and non-cumulative preferred stocks.
Cumulative vs Non-cumulative Preferred Stocks
The main difference between cumulative preferred stocks and non-cumulative preferred stocks is that cumulative preferred stocks ensure payment of all the dividends, previous as well as current, at the time of dividend declaration while non-cumulative preferred stocks only pay the current dividends at the time of declaration.
Cumulative preferred stocks are entitled to receive all the missed unpaid dividends. It is a reliable source and is valued among investors. The shareholders will receive the promised fixed amount whenever the dividends are declared. All the past omitted dividends are accumulated and assured to be paid.
While non-cumulative preferred stocks are not entitled to receive the missed unpaid dividends. It is not reliable and involves high risk as the company can terminate or suspend the shares at any time. There is no provision for the accumulation of the previously omitted dividends. There is not much assurance in the investment of non-cumulative preferred stocks.
Comparison Table Between Cumulative and Non-cumulative Preferred Stocks
| Parameters of Comparison | Cumulative Preferred Stocks | Non-cumulative Preferred Stocks |
| Definition | Type of preferred stocks that has a provision for payment of all dividends by the company | Type of preferred stocks that has no provision for payment of all dividends by the company |
| Payment of previous dividends | All the unpaid dividends gets accumulated and paid at the time of declaration | Does not pay any unpaid or omitted dividends and only pays the current dividends at the time of declaration |
| Priority of investors | Investors of cumulative stocks are paid before common stockholders | Investors of non-cumulative stocks are paid before common stockholders if the dividend is declared |
| Liquidation of company assets | Higher | Lower |
| Valuable | Highly valued | Not so highly valued |
What is Cumulative Preferred Stocks?
Cumulative preferred stocks provide provisions for the payment of dividends that have been missed out and make sure that all dividends of the company are paid to the cumulative preferred shareholders. It is a type of preferred stock or preference share.
The cumulative preferred stocks are prioritized and paid before other common classes of stock shareholders. It has a fixed dividend yield. The dividend is generally paid in the interval format. Cumulative preferred stock can receive the dividend even before the stockholders receive their payment.
Cumulative preferred stocks allow the accumulation of dividends until they are paid. It provides a right to claim dividends of the specific amount which would be received each year. Even if the dividend is not paid for any reason such as crisis or downfall, it would accumulate for a future date whenever declared. If no dividend is declared, no shareholder gets paid.
Cumulative preferred stocks provide safety to the shareholders as it guarantees the payment of dividend. These stocks are treated as perpetuity and do not allow exercising voting rights. The rate of return is the market rate when the stocks are issued. The annual dividend can be calculated by multiplying the dividend rate by the par value.
What is Non-cumulative Preferred Stocks?
Non-cumulative preferred stocks are a type of preferred stock. It does not provide a provision for the payment of unpaid dividends. If the company faces any crisis or downfall and decides not to pay the dividends, the stakeholders have no right to claim the omitted or unpaid stocks. The dividend rates of these stocks are pre-established.
Non-cumulative preferred stocks give the allowance to the companies to skip dividends and it is not obliged to the stakeholders. The company is only liable for the dividends of the current year. It puts the stakeholders in a position where they are uncertain about the payment of dividends and poses a financial risk.
Non-cumulative preferred stockholders are given priority and preference over other common stakeholders during the payment of dividends. If the company or corporation is facing a financial downfall, the directors can decide to omit, reduce or even suspend the dividends. The investors in that case have no option and their dividend is lost forever.
Whenever the next dividend is declared, the previously omitted dividends do not appear in arrears. The non-cumulative stock investment allows the company adaptability and flexibility in the management of its cash flow. The power of suspension of dividends without any penalty gives the company control over its finances.
Main Differences Between Cumulative and Non-cumulative Preferred Stocks
- Cumulative stocks accumulate the unpaid dividends and pay later when it is declared while non-cumulative stocks do not pay any unpaid dividends.
- A cumulative dividend has to be paid whereas a non-cumulative dividend can be lost forever and never paid.
- Cumulative stockholders have the right to claim their missed dividends while non-cumulative stockholders do not have any right to claim their missed or omitted dividends in the future.
- Cumulative stocks are more valuable while non-cumulative stocks are not so valuable to the shareholders.
- Cumulative preferred stocks involve low-risk investments while non-cumulative preferred stocks involve high-risk investments.
Conclusion
Preferred stocks are stable income potentials. The risk involved can be considered between that of common stocks and bonds. Preferred stocks give a fixed amount of annual dividend called the par value, whenever the dividends are declared. Even in the case of high profits, the investors would receive only the fixed promised sum of money.
During the declaration of dividends, the preferred stockholders are paid first and then the common stockholders are paid. The power of suspension of dividends is exclusively available in the non-cumulative type of preferred stocks. Before investing in any type of stock, shares, or bonds, it is important to evaluate and analyze all the terms and conditions and the market value.
References
- https://journals.co.za/doi/abs/10.10520/EJC172439
- https://www.jstor.org/stable/1112584