Venture Capital

Difference between Revenue and Capital Reserve

Revenue Reserve commonly refers to the amount of income a company incurs from their day-to-day business operations, like sales of goods and services. It is the total amount of revenue earned by the company through business operations, calculated over a set amount of time. On the other hand, a capital reserve is the cash reserve kept by the company, separate from the revenue, to meet the unprecedented or unexpected short-term expenses of an organization. These capital reserves are not generated from business operations; thus, they are created outside the capital profit that is received or generated from normal business activities. The primary difference between revenue and capital reserve is that revenue money is the one generated from the normal business operations of the company, whereas capital reserve is the capital that is reserved for a company’s future expenses or to meet any unexpected capital losses.

What is a Revenue reserve?

A revenue reserve is a reserve that is created by a company out of the profits generated from the business operations and reserved or retained to expand its business and to meet future emergencies. This revenue reserve is created to meet various future events, such as debt repayment and a buffer against potential business losses. These funds are generally not distributed among the company’s shareholders as dividends but are preserved for a future event. A company’s revenue reserve is considered an internal source of funds and finance, helping the company grow its business rapidly.

What are the Types of Revenue Reserves?

The most common types of revenue reserves are

General reserve

General reserves are those reserves of capital to meet the company’s future expansions or the intended use that is unknown at the moment.

Specific reserve

Specific reserves are those reserves of funds that are established to meet the company’s business-specific objectives. Such specific reserves are often used for redeeming the company’s debt, intermittent fluctuations, etc.

Dividend equalization Reserve

The dividend equalization reserve is the fund reserve of a company that ensures that the dividends payable to the shareholders remain stable despite fluctuations and multiple changes in the company’s business earnings.

Workmen Compensation Fund

Workmen’s compensation funds are a kind of revenue reserve that is arranged and kept by the company and earned from the company’s profit. This helps organizations meet the potential liabilities connected to the employee’s compensation if such a situation occurs.

Statutory Reserve

Statutory Reserves are those funds that a company has to reserve according to the concerned laws and regulations, for example, a company statutory reserve to meet the solvency requirements of a respective regulated industry.

Sinking Fund

Sinking funds are those funds of reserve revenue that the company set aside or reserves for repaying the debt or a bond of a company. It helps the company to soften the hardships of a company’s large outlay of revenue.

Capital Redemption reserve

Capital redemption reserve is a fund used by the company to buy back its owned shares. These funds are usually created by the organizations to meet the cost of such buybacks.

Investment Fluctuation Fund

This investment fluctuation fund is part of a specific reserve revenue to meet the change in the market value of the company’s investment.

Debenture Redemption Reserve

The debenture redemption reserve is a part of a company’s revenue reserve. It is created to pay the liabilities on debenture to the respective shareholders.

Revenue Reserve Advantages

Let us take you through an understanding of the various advantages of a company’s revenue reserve.

1. Revenue reserve helps the company meet various tiny requirements of business operations and is a great source of the company’s internal finance.
2. This revenue reserve can be distributed among the organization’s shareholders according to their requirements.
3. It is also a part of the company’s books of account and can be received as real monetary value.
4. Revenue reserves are not kept for a long term by a company but for a short period to meet the urgent requirements of the organizations. However, revenue reserves are used to replace the old assets and to repay the company’s urgent liabilities.
5. It helps the company maintain stability in its funding sources and financial position.
6. Overall, revenue reserve helps the company maintain a strong credit score, meet unexpected expenses, and overcome the challenges that may negatively impact the company’s revenue.

However, these revenue reserves are part of the company’s financial statements, and they can be used to meet various requirements of the company’s business operations depending on the specific needs, financial strategy, and models of the company.

Revenue Reserve Disadvantages

Here are the various disadvantages of the revenue reserve

1. Due to the limited flexibility, revenue reserve cannot be used for other purposes if the original plans are not aligned as per the requirements. This is because revenue reserves are fixed for meeting specific requirements of the business, like repaying the debt amount and funding future business expansion.
2. Setting aside a revenue reserve by a company reduces the profitability of organizations since less money is available for other business purposes like paying off dividends to the company’s shareholders or investing in new projects. However, this results in a low return on the shareholder’s investment.
3. Lack of transparency is another disadvantage under the revenue reserves, i.e. when a company does not make clear communications on the purpose of revenue reserve to its investors and other stakeholders, incomplete decisions will be formed without understanding and knowing the financial conditions of the respective company.
4. There is also a high chance that such revenue reserves are misused by the management for their benefit if a company does not organize to have a proper check and control over such accounts.
5. Lastly, a revenue reserve could lead to a cashflow crisis by using such revenue reserve during unexpected events and opportunities.

What do you Understand by Capital Reserve?

Capital reserve is that portion of the amount that is reserved by the company to meet future unexpected expenses created through a capital profit and not through the organization’s day-to-day business. This fund does not include any anticipated or long-term costs and is generally kept in the organization’s bank account or invested in high-liquidity securities. However, a capital profit from where the company creates the capital reserve is those profits that are commonly generated from the company’s activity that are not connected to day-to-day business operations such as premium of shares, debentures, profits from the sale of fixed assets, etc. Thus, capital reserves are commonly used by the company for meeting future capital losses, and the same is not used for paying off dividends to the shareholders.

What are the Types of Capital Reserve

Some of the types of capital reserves that a company may set aside for various specific purposes:

• Share Premium reserve

The capital reserve is created when a company sells shares at a premium amount more than the nominal value in the market. The share premium reserves are those amounts that are above the subscription price of a share.

• Capital Redemption reserve

This reserve is formed by the company when a company buys back its shares. It helps the company to record the difference between the share’s nominal value and the price paid by the company to obtain back its owned shares.

• Capital reserve

When a company obtains a surplus profit, a capital reserve is created to invest for future use. This capital reserve records the difference between the share’s nominal value and the price paid by the company to obtain back its owned shares.

• Revaluation Reserve

When a company revalues its assets, a revaluation reserve account is created by the company, such as property or investments.

• Foreign Currency Translation Reserve

This capital reserve is created by the company to record the company’s foreign currency asset value change and various other liabilities due to changes in foreign exchange rates.

• Merger and Acquisition reserve

A mergers and acquisitions reserve is created if a company is engaged in mergers and acquisitions. The objective behind such reserve is to record the difference between the price of purchase and the market fair value of the assets and liabilities acquired by the respective company.

However, it is important to note that depending upon the structures and types of a company and various other accounting and legal requirements, these types of capital reserve may differ.

Capital Reserve Advantages

Here are some of the advantages a company receives from the capital reserve account:

1. This reserve ensures the company has a stable and consistent source of funds for a long period investments and various other projects.
2. It also helps the company to grow its business and market share by funding various major acquisitions and expansions of businesses.
3. With these reserves, a company can improve its financial strength and maintain stability, leading to attracting new investors and also boosting the confidence of the existing investors.
4. These reserves also help the company to come out from the economic downfalls and various other challenges by providing funds for the company to draw on. It also helps the company safeguard itself from the negative impact on its revenue.
5. It also acts as a safeguard for a company to continue business operations when the revenue is temporarily reduced.
6. A strong credit rating can be achieved by the company through this reserve, which shall be beneficial for a company to secure funds in the future for any business operations.

Capital reserve disadvantages

Given below are a few disadvantages a company may receive using capital reserve

1. Capital reserves are often difficult to liquidate quickly since it is a long-term investment. Because of this limited liquidity, the company finds it difficult to incur cash from such reserves during unexpected or unprecedented situations.
2. It also reduces the profitability of the company since money is invested for meeting a specific purpose and not for paying dividends to the company’s shareholders or investment in new projects etc. However, this may result in a low return on the shareholders’ investment.
3. This has a potentially high risk of loss, as this reserve is invested in stock, bonds real estate, etc.
4. Once the company creates a capital reserve, they have limited control over such amount or funds management and investment. This leads to a company making a poor investment decision.
5. A company without a proper method to check and control such reserve may lead to misuse of such funds by the management of the company using them for their personal benefits.
6. In times of unforeseen events, if a company has to liquidate such funds to meet unexpected expenses, it will lose by selling off the assets at a very low price.

How is Revenue and capital reserves similar to each other?

Both capital reserves and revenue reserves are related to the concept of finance of a company connected to the stability of the company’s financial performance. Both revenue and capital reserves are used to measure the different aspects of the respective company’s financial health. Some of the common similarities between revenue reserve and capital reserve are:

1. They are both considered assets to the companies.
2.  Both are utilized by the company to invest in the growth of a company.
3. The company used this capital and revenue reserve to measure the company’s financial performance and conditions.

Key differences between the Revenue Reserve and Capital Reserve

Given below are the major key differences between Revenue reserve and capital reserve

1. Revenue reserves are those funds that are retained by a company from their business operation profit to meet the company’s unexpected future expenses or losses. Meanwhile, a capital reserve is a fund created by the company to meet a specific purpose of the company expenses, such as financing large-scale projects or various other write-off capital expenditures.
2. The sources of funds for revenue reserves are taken out from the profits derived from the company’s day-to-day business operation activities. Meanwhile, the sources of capital reserve funds are derived from the company’s non-operating business operations.
3. The primary objective of a company behind creating a revenue reserve is to meet the unprecedented event and improve the financial position of the company. On the other hand, a capital reserve is created by a company to meet the legal requirements or accounting principles.
4. Capital reserves created by a company are taken as a part of the equity section of the respective company’s balance sheet, whereas revenue reserve is considered as a part of the company’s income.
5. Capital revenue is not often received by a company in monetary value. On the other hand, revenue reserve is always received by a company in a monetary value.
6. A company creates a capital reserve by selling a fixed asset of a company, whereas a company creates reserve revenue from day-to-day business operation earnings.
7. These capital reserve funds cannot be distributed among the company’s shareholders as a dividend. Whereas revenue reserve funds can be distributed as divided among the company’s shareholders.

Conclusion

It is indeed, important for the company to create reserve funds to safeguard the company business from falling or any unexpected contingencies that may arise in the future. It also helps the company maintain stability and strengthen its financial condition. A company’s revenue reserve fund represents the company’s operational efficiency, unlike a capital reserve. Companies with the help of reserve funds can safeguard the fall down of the business operations and repay the long-term debt as a debenture.