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Sun Dec 8, 2024
Do you remember the iconic scene from Mujhse Shaadi Karoge where Salman Khan divides his earnings into three piggy banks for specific purposes—his grandmother’s operation, sister’s education, and his own marriage?
That scene beautifully illustrates the concept of reserves in finance. Just like Salman allocates his earnings for future needs, companies set aside portions of their profits for specific goals.
Welcome to Day 6 of our 50 Days Finance Challenge, where we’ll uncover the role and importance of Reserves and Surplus in a company’s financial health | What Are Reserves and How Are They Created?
In simple terms, reserves are profits retained by a company after distributing dividends to shareholders. Let’s break it down:
Let’s explore some common ones:
a) Sinking Fund Reserve:Created to accumulate funds for repaying long-term liabilities or replacing significant assets.
Example: Funds set aside for building repairs or replacement after its lifecycle.b) Depreciation Reserve: Helps cover the cost of replacing assets like machinery, ensuring no financial shock when the replacement becomes necessary.
c) Capital or Debenture Redemption Reserve: If a company issues redeemable shares or debentures, it creates a reserve to ensure timely repayment to investors.
d) Statutory Reserve: Certain industries, like banking, are legally required to transfer a portion of profits to reserves as per regulatory guidelines.
e) General Reserve: A flexible reserve created without a specific purpose. Companies use it for expansion, contingencies, or other strategic goals.
f) Contingency Reserve: Set aside to prepare for potential liabilities like court cases or penalties that might arise in the future.
Reserves act as a financial safety net, ensuring a company can:
How Companies Utilize Reserves?
An efficient finance manager ensures reserves are invested rather than lying idle. These investments generate returns, further strengthening the company’s financial position. Think of it as placing Salman’s piggy bank money into profitable ventures!
A Fun Fact: Reserves as Liabilities?Interestingly, reserves appear as liabilities on the balance sheet. Why?
Because a company is a separate legal entity from its shareholders. The company owes its profits (including reserves) to its shareholders, making it a liability in accounting terms.
Reserves are more than just savings; they’re strategic tools that ensure a company’s resilience and future growth. Whether it’s funding emergencies, expansions, or paying dividends, reserves are the backbone of a sound financial structure.
Stay tuned for Day 7 of the 50 Days Finance Challenge, where we’ll dive into another crucial financial concept. Until then, keep learning and investing in your knowledge!Happy Learning! 😊
Prof. Sheetal Kunder
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