# Dividend coverage ratio

Dividend coverage ratio shows the number of times the dividend is covered by available profit and is calculated separately for each class of shares.

## Formula and for ordinary (common) shares: ## Example

Profit before tax: \$480,000
Corporation tax rate: 50%
Dividend to preference shareholders: \$15,000
Dividend to ordinary shareholders: \$25,000

Calculate dividend coverage ratio for the use of both preference shareholders and ordinary (common) share holders.

### Solution:

For preference shareholders:
Dividend coverage ratio = (480,000 – 240,000)/\$15,000
= 16 times

For ordinary (common) shareholders:
Dividend coverage ratio = (\$480,000 – \$240,000 – \$15,000)/\$25,000
9 times

A high dividend coverage ratio is the indication of the fact that the company will continue to be able to pay similar or higher dividends in future. A low dividend coverage ratio, on the other hand, shows that even a small decrease in company’s profit will result in reduction in the dividend rate – in other words, the dividends may not be safe. Obviously, a high dividend coverage command better price at the stock exchange.

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