How to Determine Dividend Policy & Capital Structure

Use the Annual Report to understand the firm's capital structure.

Companies can obtain capital by issuing bonds and selling equity shares in the company. The mixture of bonds and equity shares is referred to as a firm's capital structure. Bondholders receive compensation for the use of funds with interest and shareholders receive compensation through share price appreciation and/or dividends. Dividends are paid out to shareholders with company earnings and not all companies issue dividends, but those that do will create a dividend policy and share it with shareholders in the Annual Report.

Instructions

1. Request or download the Annual Report. You can find it on the company's website or by contacting the company's Investor Relations department.

2. Turn to the Balance Sheet. On the Balance Sheet, debt is referred to as Liabilities. Specifically, you are interested in the line item long-term debt. Equity is referred to as Stockholders' Equity on the Balance Sheet. The ratio of debt to equity is the most common measure used to compare a firm's capital structure. For instance, a firm with $10,000 in long-term debt and $20,000 in equity has a capital structure consisting of 33 percent debt and 66 percent equity. You can also find a discussion of the firm's capital structure in the notes to the Balance Sheet.

3. Turn to the notes to the Income Statement. Dividends are considered a distribution of earnings. Therefore, the dividend policy is commonly discussed in the notes to the Income Statement. You may also find a brief discussion of the firm's dividend policy in the notes to the Cash Flow statement which also appears in the Annual Report.

References

• WSJ: Why Capital Structure Matters
• StudyFinance: Dividends