Dividend Coverage Ratio Formula & Definition Explained

What is Dividend Coverage Ratio

Dividend coverage ratio is a financial ratio that measures the number of times that the company can pay out dividends to shareholders by its net income. The dividend coverage ratio is a comparison between the company’s net income and the dividends paid out to the shareholders.

The dividend coverage ratio (DCR) is a tool that helps investors to estimate the risk associated with the company’s dividends. Thus, the higher DCR the lower risk that the company will not be able to pay out the dividends. Conversely, the lower DCR may indicate that the company struggles to sustain the level of dividends due to its lower income.

When a dividend coverage ratio is more than 1 means the company generates income enough for dividend payments. As a rule of thumb, a dividend coverage ratio that more than 2 is a good dividend coverage ratio because it means the company’s net income can pay the dividend more than twice, which means the company is still able to reinvestment or the possibility of a downturn. Conversely, a negative DCR is both unusual and a clear sign that the company is in trouble.

Dividend Coverage Ratio Formula

The dividend coverage ratio can be calculated by dividing the net income by the dividend payout to determine how many times the net income is available to pay the dividend to the shareholders, as the following dividend coverage ratio formula:

DCR = Net Income / Dividend Payout

or

DCR = (Net Income – Preferred Dividend) / Common Dividend Payout

The dividend coverage ratio formula is the inverse of the dividend payout ratio formula.

For example, the company paid out the dividends of $1 million and the company net income was $6 million. The dividend coverage ratio will be: 6,000,000 / 1,000,000 = 6x. The DCR of 6 means the company can payout dividends 6 times compared to the net income.

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