Definition
Reserves and Surplus in finance refer to the portion of profits a company retains after paying off its liabilities and dividends. Reserves are typically used for business expansion, future investments, or to cover unforeseen costs or losses. Surplus, on the other hand, is the amount of assets that exceed the company’s liabilities.
Key Takeaways
- Reserves and Surplus represent the portion of profits or earnings that a company retains within the business after paying off dividends. It signifies the accumulated profits which are not distributed out as dividends.
- This financial term forms an important part of a company’s net worth and is reflected under shareholder’s equity in the balance sheet. It acts as a safeguard against unforeseen future economic challenges and helps to finance the company’s growth initiatives or pay off future liabilities.
- A healthy level of reserves and surplus indicates the company’s financial stability, while a continuous decline or a negative balance can be a potential signal about the company’s weakening financial position and mismanagement.
Importance
Reserves and Surplus is an essential term in finance because it refers to the portion of a company’s profits that has been saved, allocated or retained for future use, eventually contributing to the company’s net worth.
This amount is intended to strengthen the financial position, absorb any future uncertainties or losses, and support such objectives as business expansion, payoff of liabilities, or reinvestment back into the business.
By evaluating the Reserves and Surplus, stakeholders can gain insights into the company’s profitability, financial health, and management’s financial strategy, which can then guide their decision-making process related to that company.
Thus, Reserves and Surplus plays a pivotal role in business sustainability and investment planning.
Explanation
The purpose of Reserves and Surplus is to act as a safety net for businesses against potential financial troubles or downturns in the future. It essentially serves as an internal source of funds which can be used for purposes like business expansion, launching new products, venturing into new markets, reducing the long-term debts, or even to cushion against unexpected financial shocks.
Proper utilization of these funds can enable the company to attain financial stability while also providing the required resources to make strategic business decisions. Furthermore, Reserves and Surplus is often perceived as a measure of a company’s profitability and financial health.
It can be used by investors and shareholders as an indicator of the company’s ability to generate profits over expenses, further translating into its capacity to distribute dividends. Conversely, a persistently low or declining Reserves and Surplus may raise red flags about the company’s performance and stability.
Thus, management of these funds is critically essential, both for operational purposes and for maintaining investor confidence and market reputation.
Examples of Reserves and Surplus
Apple Inc.: As per its balance sheet for the fiscal year 2020, Apple’s retained earnings, which is a part of reserves and surplus, amounts to a whopping USD 14,966 billion, which is an increase from its 2019 figures of USD 14,884 billion. This large reserve and surplus helps the company in making new investments, dealing with potential crises, or paying dividends to its shareholders.
Microsoft Corporation: As at the end of the fiscal year 2021, Microsoft’s retained earnings were USD 71,675 million, significantly higher than the previous year. This reserve and surplus helps the company to invest in research and development, acquire new businesses, and ensure steady returns for the shareholders.
Walmart Inc: According to the company’s 2021 annual report, Walmart’s retained earnings were over USD 82 billion. These reserves and surplus help Walmart in expanding their operations, launching new stores, and upgrading their infrastructure for better customer service. It also helps the company to pay dividends and maintain a favorable financial position even during economic downturns.
FAQs on Reserves and Surplus
What are Reserves and Surplus?
Reserves and Surplus is a key financial metric that represents a part of an organization’s profits that have been set aside and saved for potential future use. It acts as a cushion against unforeseen financial requirements or losses. It helps companies achieve their long-term goals and provides stability during financial distress.
What is the importance of Reserves and Surplus?
Having adequate Reserves and Surplus is crucial for any company as it ensures their financial stability and strength. Besides, it can also be used for reinvestments, to distribute dividends among the shareholders, for settling debts, or for expansion activities.
What is the difference between reserves and surplus?
In financial terms, reserves refer to the profit earned by a company and set aside to strengthen the business financial position. The surplus, on the other hand, refers to the residual balance in the profit and loss account after appropriation (distribution of profit among shareholders as dividends) has been made.
How are Reserves and Surplus calculated?
Reserves and Surplus is calculated by several methods depending on the company’s policy. This could include the retention of a certain percentage of profits, saving a fixed amount annually, or adding specific capital infusions directly to this account.
Related Entrepreneurship Terms
- Retained Earnings: This is the profit that the company keeps for reinvestment rather than paying it out to shareholders as dividends.
- Capital Reserve: This is a reserve created from capital gains and is not readily distributable as cash dividends to shareholders. It is used for long-term purposes, such as buying a fixed asset or writing off a loss.
- Revenue Reserve: This is a portion of the profit earned by a business that is set aside to strengthen the company’s financial position.
- Sinking Fund: A reserve fund set up by a company to pay off debt as it becomes due. It helps improve creditworthiness by showing the company is making efforts to repay their debt.
- Statutory Reserve: This is a reserve fund mandated by regulation. Companies are legally required to maintain these reserves to cover certain types of potential losses.
Sources for More Information
- Investopedia: This is a trusted online resource for a broad range of financial terms and concepts.
- Accounting Tools: This website provides in-depth explanations and educational material on a wide range of accounting and financial topics.
- SmartMoneyGoal: This is a personal finance blog that provides easy-to-understand explanations of financial terms like “reserves and surplus”.
- Corporate Finance Institute (CFI): This institute offers online courses that cover financial concepts, one of which is “reserves and surplus”.
