In rain – deficit areas people store water by building wells and reservoir so that in times of drought they can use that water for smooth functioning of their day to day activities, in the same way in business companies save money in the form of reserves so that in times of financial uncertainty these reserves can be used by the company for smooth functioning of their day to day activities. Reserves are the most important source as far as the company is concerned because when no one is willing to help it is these reserves which come to rescue for the company. Reserves can be defined as those which are created by retaining profits of the company, there are many types of reserves, let’s look at some of them –
- General Reserve – As the name suggests it is that reserve which is general in nature implying that it can be used for any purpose by the company. General reserve can be used for a variety of purpose like if the company incurs a loss in one year then company can use general reserve or if the company loses lawsuit then also general reserve can be used or it can be used for paying dividends to shareholders or company can write off bad debt against general reserve and so on.
- Investment Fluctuation Reserve – This is specific reserve made by the company only for loss arising out of fluctuation in investments made by the company. For example if the company has made an investment in equity markets and due to some reason equity market decline and company incurs loss then the company can use this reserve, same is the case with other investments like investment in real estate, gold, bonds and so on.
- Debenture Redemption Reserve – This reserve is created by the company when a company issues debenture because when debenture redemption date approaches and company has not enough profits to redeem the debenture then it will result in a loss to the debenture holders. Debenture redemption reserve in a way helps the company in advance for upcoming redemption payment of debenture as it is easy to appropriate yearly fixed amount rather than allocating it in one single year of redemption.
- Dividend Equalization Reserve – As the name suggests this type of reserve is created by the company so that company can pay regular dividends to the shareholders of the company. In the case of dividend equalization reserve, company transfer money in the years when the company makes more profits so that it can be used in years where the company makes low or no profits so that dividend payment is not affected.
- Capital Reserve – This type of reserve represents those profits which are not made in the normal course of the business rather this type of profits have been made by the company due to some extraordinary transactions like selling a capital asset like land or building or investments made by the company and so on. This reserve is not available for shareholders; however it can be used by the company for writing off capital losses like the loss on investments made by the company or loss arising from the sale of old fixed assets like plant and machinery, furniture and so on.
- Foreign Currency Translation Reserve – This type of reserve is created by those companies which have exposure to international markets. The purpose of creating this reserve is to cover the loss arising from converting foreign currency to domestic currency because there is time lag between company selling the goods to foreign markets and receiving payment from such transactions and exchange rate never remains same and they keep fluctuating which may result in loss for the company if exchange rate moves adversely for the company.
As one can see from the above that there are many kinds of reserves but the basic premise remains the same that is to save money for hard times or in other words hoping for best but preparing for the worst.