Reserves and Surplus

When You start investing in the stock market, it is necessary for you to read the balance sheet of any company as it plays a critical role in informing you about the company. However, there are some terms in the balance sheet which are unknown for many people like reserves and surplus.

Let’s understand them with an example and their types as well.

What is Reserves and Surplus?

Reserves and surplus are the total amount of maintained earnings reported as a component of Shareholders Equity and set aside by the firm for specified objectives such as purchasing fixed assets, paying legal settlements, repaying debts, or paying dividends, and some others.

Different types of Reserves and Surplus in Balance Sheet

There are majorly 4 types of Reserves & Surplus you will find in a balance sheet which are:

General Reserve

A revenue reserve is another name for a general reserve. Revenue reserves are the funds set aside by a company from its earnings for the objective of future use. It is purely a corporation’s retained earnings, which are set aside from profits to meet specific or unclear responsibilities.
Capital Reserve

A capital reserve is a portion of a company’s profit that is set aside for a particular reason, such as financing long-term initiatives or deferring capital expenditure. This reserve is made up of any capital profit obtained by a firm from sources other than the organisation ‘s primary business.
Capital Redemption Reserve

On the redemption of preference stocks or throughout the buyback of own stocks to decrease the share capital, the Capital Redemption Reserve is established from the undistributed earnings in the general reserve or the profit and loss account.
Dividend Reserve

The money maintained in a separate account for securing that a similar amount of dividend is announced annually is known as the dividend reserve.

Example of Reserves and Surplus

Consider the case of Britannia, a FMCG company. Throughout the financial year 2020–21, the firm earned INR 3,038 Cr. through its usual operation of business. The management team has agreed to set aside 7% of earnings produced over the financial year for future obligations for the General Reserve.

The firm has distributed stocks for which they have secured a INR 350 cr. premium. Over the same time period, the amount in capital redemption reserve and dividend reserve was INR 140 cr. and INR 190 cr. separately.

Total Reserve and Surplus

The overall amount of reserves and surplus will be equal to the total of the general reserve, stock premium account, capital redemption reserve, and dividend reserve. The Overall Reserves and Surplus = 212.66 (3,038 * 7%) + 350 + 140 + 190 = INR 892.66 Cr.

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Benefits of Reserve and Surplus

These are the main benefits :

Internal financing

Reserves are regarded as the most important source of internal financing. When the firm requires funds for its commercial operations or to satisfy its obligations, the first and most convenient source of funds is the company’s generated general reserves.
Working Capital Requirements

The firm can sustain its working capital needs with the support of reserves since reserves can be used to boost working capital when the company’s working capital is insufficient.
Liabilities

Another major benefit of having reserves and surplus is that it allows organisations to withstand future losses by using time of loss reserves to pay off present liabilities.
Dividend Distribution

The majority of the money needed for dividend distribution comes from reserves. It assists in preserving dividend distribution rate similarity by offering the amount necessary to keep the dividend rate uniformity when there is a deficit of funds accessible for distribution.

Drawbacks of Reserve and Surplus

These are the main Drawbacks:

At the time of losses

If a firm has losses and those losses are adjusted/set-off against the firm’s reserves, the accounts will be manipulated in some way since the true picture of the firm’s profitability will not be presented to the financial statement readers.
Misuse of Funds

The general reserves, which make up the majority of reserves and surplus, are not set aside for any particular reason. However, because of the widespread use, there is a risk that funds collected in general reserves will be misappropriated by the management team, and that the money will not be used appropriately for business growth.
Extra Reserves

The creation of extra reserves may result in a decrease in dividend payouts to investors.

Key Takeaways

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The reserves and surplus established by the firm are the reserves that the company can use for whatever reason they are produced for, depending on the kind or type of reserve and surplus. In most cases, these reserves are established by the corporation to cover any future emergencies.
Dividend distribution, meeting future liabilities, recovering losses, handling working capital needs, meeting finances required for business expansion, and so on are all examples of how reserves and excess are used.
To offset the loss in sales and slow-paying consumers, the corporation must keep cash reserves on hand at times. In general, the amount of cash reserves a firm keeps is defined by the nature of business it does.

Conclusion

To deal with declining income and slow-paying consumers, cash reserves and surpluses are often maintained. However, Please keep an eye on this kind of company as this can be risky.

This is all from our side regardingreserves and surplus are which form of financing. Let us know your views in the comment section.

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FAQ About Reserve and surplus

Reserve and surplus are shown under

Reserve and surplus are shown under liability in balance sheet.