Dividend and Working Capital Policy
What the domain tests
This domain tests dividend policy theories and practical distribution rules, plus management of cash, receivables, inventory and payables. Questions often compute the cash conversion cycle or evaluate a credit policy.
Core rules and concepts
- Dividend irrelevance (Modigliani–Miller) assumes perfect markets; in practice, taxes, signalling, agency costs, clientele effects and legal distributable profits matter.
- Residual dividend policy pays dividends only after funding positive-NPV investments with retained earnings. Stable dividends signal confidence; a cut can signal distress.
- CAMA 2020 limits distributions to distributable profits and requires solvency; dividends should not be paid out of capital.
- Working capital policy: aggressive (low current assets, high risk), conservative (high current assets, low risk), matching (maturity matching).
- Cash conversion cycle = inventory days + receivable days − payable days.
- Baumol model: optimal cash conversion = √(2 × annual cash need × transaction cost ÷ opportunity cost). Miller–Orr allows stochastic cash flows.
Worked example
Inventory days 60, receivable days 45, payable days 30. CCC = 60 + 45 − 30 = 75 days. Annual cost of sales is N730m, so daily = N2m. The company funds about 75 × N2m = N150m of operating working capital. If it cuts receivable days to 30, CCC falls to 60 days and funding need falls to N120m, releasing N30m-subject to not damaging sales.
Traps that cost marks
Do not equate profit with cash; ignore seasonality; calculate CCC with sales instead of cost of sales for payable and inventory days; recommend stretching payables without considering supplier risk; or pay dividends that breach distributable profits.