A target payout ratio is a specific goal that a company has set for the payout ratio achieved by the business. The ratio focuses on creating the ideal balance between the percentage of collected revenue that is set aside for paying dividends to investors, as well as creating an allocation process that ensures that target or goal is met consistently. Calculating this type of ratio calls for projecting realistic goals for revenue generation, making it easier to determine when and how much of that revenue to set aside in order to pay the agreed upon amount in dividends to the investors.
At its base, the target payout ratio is an goal that is set after developing a good idea of how much earnings will occur in a given accounting period and using that data to set an equitable benchmark for paying out dividends. Typically, the target payout is expressed as a percentage of those earning, with that percentage set based on the total revenue collected but allowing for the debt obligations of the business and the need to keep the company financially solvent. Since the target payout ratio is a percentage, this means that the actual amount of dividends paid to an investor will vary based on the actual income generated during the period under consideration. The benefit for the company is that since the ratio is that during periods in which lower earnings are experienced, the actual amount of the dividend payments will be less, creating less of a financial strain on the company’s resources.
Since the target payout ratio is, in fact, a goal, there is always the possibility that a company will not meet that goal. This may come about due to the occurrence of events that are beyond the control of the business and are included in the range of events that allow the company to defer or not issue dividend payments for that accounting period. In addition, if the ratio is not based on reasonable projections for income, there is a good chance that achieving the goal will be difficult, if not impossible.
Determining a target payout ratio that is reasonable in terms of the company’s performance and the need to generate equitable dividend payments to investors does require careful consideration of all aspects of the operation. The ability of the company to increase sales that result in greater collected revenue, the opportunity to reduce costs so that a larger share of those profits can be allocated to making dividend payments, and even considering the prospects for the economy in general will all come into play. By properly assessing all known factors, it is possible to determine a workable target payout ratio that is in the best interests of everyone involved.