Difference Between Capital Reserve and Reserve Capital
When it comes to a company’s finances, it is important to have a clear understanding of the various terms and concepts that make up its financial statements. Two such terms that are often used interchangeably but have distinct differences are capital reserve and reserve capital.
Capital Reserve
A capital reserve is a portion of a company’s profits that has been set aside for a specific purpose. This reserve is not meant to be distributed among shareholders as dividends but is instead used to fund specific activities such as buying assets or paying off debts. Capital reserves are typically created when a company generates profits from its operations or sells assets at a higher price than they were purchased for. These reserves are recorded on the company’s balance sheet under the equity section.
The creation of a capital reserve can be voluntary or mandatory. For instance, a company may choose to create a capital reserve to fund a large-scale research and development project or to invest in new technology. Alternatively, some countries may require companies to create a capital reserve fund as a part of their regulatory compliance. The usage of a capital reserve must be in accordance with the company’s objectives and cannot be used for any other purposes.
Reserve Capital
Reserve capital, on the other hand, is not related to a company’s profits. It refers to the amount of money that has been set aside by a company at the time of its formation to protect the interests of its creditors. This reserve is also known as the authorized share capital or nominal capital. Reserve capital is the maximum amount of share capital that a company is authorized to issue as per its Memorandum of Association. It is recorded on the company’s balance sheet under the liability section.
Reserve capital is not used by the company to fund its operations or any other external activities. Instead, it acts as a cushion for the company’s creditors in case of liquidation. In case a company is unable to pay off its debts, the creditors can lay claim to the reserve capital to recover their investments.
In Conclusion
To summarize, while both capital reserve and reserve capital involve setting aside funds for future use, they have distinct differences that businesses should understand. Capital reserves are related to profits and are created to fund specific activities, while reserve capital is related to a company’s share capital and serves as a protective measure for creditors. Understanding these differences is crucial for financial planning and decision-making.
Table difference between capital reserve and reserve capital
| Capital Reserve | Reserve Capital |
|---|---|
| Capital reserve is created out of the profits earned by a company. | Reserve capital consists of the amount of money that shareholders have committed to pay for shares but have not yet paid. |
| Capital reserve is not available for distribution as dividend. | Reserve capital can be utilized for issuing shares or for utilizing as capital. |
| Capital reserve is used to meet future contingencies, such as the purchase of fixed assets or repayment of debt. | Reserve capital is created to ensure that a company has adequate capital for funding its operations. |
| Capital reserve is shown as a separate line item in the balance sheet under the head of reserves and surplus. | Reserve capital is shown as a separate line item under the head of share capital in the balance sheet. |