Cumulative preference shares give the shareholder a right to dividends that may have been missed in the past. Dividends are paid by companies to reward shareholders. But it is not entitled to pay it. Companies may pay reduced dividends, or even halt paying dividends for some time, and when it resumes, then cumulative preferred shareholders must receive all dividends in arrears. They are entitled to these before the holders of common shares can receive dividends once more.
For example, suppose a company issues cumulative preference shares worth Rs 1,000 each, promising to pay out 10 per cent annually. In Year One, the economy is in good financial health and pays out its dividend in full, meaning the cumulative preferred shareholder gets Rs 100. But in Year Two, the economy slows down and the company can only afford to pay out half the dividend, that is Rs 50. In Year Three, the business environment worsens and the company halts dividend payment. The total due to the shareholder is now Rs 150 (Rs 100 for third year and balance Rs 50 from the second year). In Year Four, the economy rebounds and resumes dividend payments. The cumulative preferred shareholder must be paid Rs 150 in arrears, plus Year Four dividend of Rs 100. Cumulative preferred shareholders must be paid before the company can pay a dividend to other classes of shareholders.
Source: Economic Times
