Dividend Coverage Ratio
It measures the ability of a firm to pay dividend on preference shares which carry a stated rate of return. This ratio is the ratio (expressed as x number of times) of net profits after taxes (EAT) and the amount of preference dividend. Thus,
It can be seen that although preference dividend is a fixed obligation, the earnings taken into account are after taxes. This is because, unlike debt on which interest is a charge on the profits of the firm, the preference dividend is treated as an appropriation of profit. The ratio, like the interest coverage ratio, reveals the safety margin available to the preference shareholders. As a rule, the higher the coverage, the better it is from their point of view.