Payout refers to the expected financial returns or monetary disbursements from investments or annuities. In terms of financial securities, payouts are the amounts received at certain intervals, such as monthly annuity payments. In simple terms, a payout is a taxable payment made by a company to its stakeholders from the company’s current or retained earnings. Here we have talked about payout ratio, its formula, example, calculation, relevance, and use in detail.
Understanding Payout
In terms of financial securities, such as dividends and annuities, payouts refer to the amounts received at given points in time. For example, in the case of an annuity, payouts are given to the annuitant at regular intervals such as quarterly or monthly.
Payout is basically- ‘money paid, expended or disbursed as a dividend. A company’s payout ratio or dividend payout ratio gives investors an idea of how much money it returns to its shareholders compared to how much money it keeps on hand to reinvest in growth, pay off existing debt or add to cash reserves. A structured financial management system is the pillar of any prosperous business strategy. As much as a business would like to focus on great cash inflow, making payouts is also an equally important task.
Payout Ratio as a measure of Distribution
There are basically two methods in which companies can distribute earnings to investors:
1. Dividends, 2. Share Buybacks
In the case of dividends, payouts are made by corporations to their investors and are generally made in the form of cash dividends or stock dividends. Here the payout ratio is the percentage rate of income the company pays out to the investors in the form of distributions. Where some payout ratios include both dividends and share buybacks, others only include dividends. For example, a payout ratio of 30% means that a company pays out 30% of its distributions. Newly formed companies or start-ups tend to have low payout ratios. Hence investors in such companies rely more on share price appreciation for returns rather than dividends and share buybacks.
What is the Payout Ratio Formula?
The term ‘Payout Ratio’ also known as ‘Dividend Payout Ratio’ refers to the proportion of the net income paid to the shareholders in the form of dividends. In simple terms, it is the percentage of the company’s earnings paid out to the investors. The payout ratio is calculated using the following formula-
| Payout Ratio= Total Dividends / Net Income |
The payout ratio can also include share repurchase, in which case the formula becomes-
| Payout Ratio= (Total Dividends + Share Buybacks) / Net Income |
The ratio can be easily calculated by using the above-mentioned formula. The payout ratio is simply a way to figure out what percentage of the company’s earnings are being paid out in the form of dividends.
Example of Payout Ratio Formula- How to Calculate?
| Let us take an example of company X that reported a net income of Rs. 80 crore during the year out of which it paid out Rs. 40 crore as dividends to shareholders. Now, what will be the Payout Ratio?
Here, Net Income is Rs. 80 crore and Total Dividend is Rs. 40 crore. The payout ratio will be calculated using the same formula as mentioned above- Payout Ratio= Total Dividends / Net Income Payout Ratio= Rs. 40 crore / Rs. 80 crore X 100 PAYOUT RATIO= 40% |
Hence, the company’s payout ratio is 40%. Generally, a payout ratio of 60% or less is considered to be safe. It is said that- the lower the percentage is, the safer the dividend.
People who are generally concerned about the safety of their dividend income should regularly keep an eye on the payout ratio. In the above-mentioned example, the dividend payout ratio is 50%. This is considered to be a healthy dividend payout ratio because even if the company’s earnings were to fall 10% or 20%, it would still have plenty of resources to pay the dividends.
Relevance and use of Payout Ratio Formula
The concept of payout ratio is important for both companies and investors. Some of the companies use a higher payout ratio to keep the investors interested. The dividend payout ratio surely indicates a strong liquidity position. However, a too high payout ratio may be indicative of low investment in future growth.
You might see some investors who tend to value a dividend-paying stock more when compared to a non-dividend-paying stock. In fact, the majority of investors are happy to receive dividends regularly as they see it as a steady source of cash flow. Similarly, the dividend makes the stocks more desirable which eventually results in increased market value.
Also Check: Dividend Payout Ratio and its Types, Formula & Calculation
Frequently Asked Questions (FAQs)
What is the Payout amount?
A payout is a sum of money, especially a large one, that is paid to someone, for example, by an insurance company.
What does the payout ratio tell us?
The payout ratio, also known as the dividend payout ratio, shows the percentage of a company’s earnings paid out as dividends to shareholders. A payout ratio over 100% indicates that the company is paying out more in dividends than its earnings can support, which some view as an unsustainable practice.
Why is payout ratio important?
The payout ratio is important because it tells investors how much of the company’s profits are being given back to shareholders. Said another way, a payout ratio of 20% means for every rupee the company earns in net income, 20% is being returned to shareholders as a dividend.
What does a negative payout ratio mean?
When a company generates negative earnings, or a net loss, and still pays a dividend, it has a negative payout ratio. A negative payout ratio of any size is typically a bad sign. It means the company had to use existing cash or raise additional money to pay the dividend.
What is cash dividend payout ratio?
The cash dividend payout ratio measures the proportion of cash flow a company pays to common-stockholders after subtracting preferred dividend payments. It shows what percentage of a company’s net income is being paid in the form of cash dividends.