# Dividend Coverage Ratio

### Reviewed by Subject Matter Experts

Updated on February 17, 2023

The dividend coverage ratio indicates the number of times that a dividend is covered by available profit. It is calculated separately for each class of shares.

## Formula

To calculate the dividend coverage ratio for preference shares, use the following formula:

For ordinary (common) shares, apply this formula:

## Example

Consider the following information relating to a company:

• Profit before tax: \$480,000
• Corporation tax rate: 50%

Required: Calculate the dividend coverage ratio for preference shareholders and ordinary (common) shareholders.

## 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

## Interpretation

A high dividend coverage ratio shows that a company has the ability to pay similar or higher dividends in the future.

A low dividend coverage ratio, on the other hand, shows that even a small decrease in the company's profit will result in a reduction in the dividend rate—in other words, the dividends may not be safe.

Obviously, companies with high dividend coverage ratios typically command better prices if they are listed on a stock exchange.