(^60) Financial Management
Reserves & Surplus
General Reserves is the name given to the aggregate amount of corporate earning that
has been reinvested in the business. There is another reserve called share premium
reserve, which represents the premium charged when the company issued shares.
The third is the surplus that comes from the profit and loss account. All these
together constitute 'Reserves and Surplus'. The reserve and surplus as a whole increases
each year by the net income that is retained in the company and decreases by
losses.
You should note that the reserves and surplus does not mean cash. In fact, the company
can have large reserves and surplus position and be without cash or it can have a lot of
cash and a very small reserves and surplus balance. Although both cash and reserves
& surplus usually increase when a company earns, the amount by which each one
increases is usually different. Two reasons can be attributed for this difference.
- The net profit of the company is calculated on accrual basis and not on a cash
basis. Therefore, reserves & surplus would show increase on an accrual basis as
against cash, which will only show increase if there is real inflow of cash. - The cash generated from the net profit can be invested in assets, can be used to
pay off loans or spend in any number of ways, both of which would not affect net
income or reserves and surplus. For example, if a Managing Director buys a
Mercedes car for himself on company's account, he is basically making an expense
that would not be reflected in the net income or reserves and surplus but would be
reflected in the cash position of the company.
To summarise cash is an asset and retained earning is one of the sources of financing
(along with share issues and loans) that a company can use for its business
purposes.
In the figure 2.3 below, you can see the reserves and surplus figures of Cosco.
Figure 2.3: Reserves & Surplus
There are three items that you can notice in the figure. Let us discuss each one of them
one by one. The share premium account shows a balance of Rs 31,230,000 which is
unchanged from the last year closing balance. This means that company did not issue