LESSON 3.3 · CORE

Earnings-based vs cash-based payout ratios

Profit is an opinion, cash is a fact. Two payout ratios, two different answers.

DIVIDEND DURABILITY4 MIN READ

The usual payout ratio divides dividends by profit, and profit is full of accruals: sales booked before the customer pays, costs spread over years, write-downs and estimates. That's legitimate accounting, but it means profit and cash can drift apart for years. The FCF payout ratio divides dividends by free cash flow instead — the cash left after running and maintaining the business.

When the two agree, there's nothing to reconcile. When the earnings ratio says 50% and the cash ratio says 110%, the dividend is being paid from something other than this year's cash: savings, borrowing or selling assets. A holding's detail shows the earnings version as Payout Ratio and a cash check as Cash Flow — operating cash flow ÷ dividends paid, from the latest annual report. That's before capital spending, so it looks kinder than an FCF ratio would; for the stricter one, take capital spending off operating cash flow in the company's cash flow statement. Both change only when the company reports (data latency).

£50m dividend ÷ £100m profit = 50%£50m dividend ÷ £45m free cash flow = 111%

Same dividend, same year, illustrative numbers. Only one of those ratios was paid for in cash.

Compare Payout Ratio and Cash Flow in a holding →

Educational content only. It is not personal financial advice.