Difference between Capital Reserve and Revenue Reserve

Difference between Capital Reserve and Revenue Reserve

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Chanchal
Chanchal Aggarwal
Senior Executive Content
Updated on Feb 9, 2024 01:36 IST

Revenue reserves are derived from a company's operational earnings and can be used to pay dividends. In contrast, capital reserves originate from non-operational activities, like asset sales, and are typically not distributable as dividends but used for business expansion or to strengthen financial stability.

Why do companies differentiate between capital reserve and revenue reserve? Capital reserve is formed from non-operational gains, like profits from selling a building, earmarked for significant investments or covering capital losses. Revenue reserve, derived from operational profits such as annual sales, is used for regular business growth and paying dividends. Understanding this distinction helps businesses strategize financial management, ensuring stability and growth through precise allocation of resources.

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Table of Content

Comparative Table: Capital Reserve and Revenue Reserve

Aspect

Capital Reserve

Revenue Reserve

Source of Funds

Non-operational activities (e.g., sale of fixed assets, issuance of shares above par value)

Operational profits (e.g., earnings from business activities)

Purpose

Financing expansion, issuing bonus shares, covering capital expenses or losses

Financing future expansion, dividend payment, absorbing operational losses

Distribution

Not typically used for dividends

Can be used for paying dividends

Occurrence

One-time or occasional, based on specific transactions

Regular, from ongoing operational profits

Nature

Non-recurring and linked to specific capital transactions

Recurring and generated from core business operations

Regulatory Aspect

May be influenced by specific legal or regulatory requirements in some cases

Largely discretionary, based on company policy and performance



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What is Capital Reserve?

Capital reserve is a fund derived from non-operational activities, such as the sale of fixed assets, issuance of shares above par value, or revaluation surpluses. It's earmarked for financing business expansion, issuing bonus shares, or covering capital losses. Unlike revenue reserves, capital reserves are not typically used for dividend distribution, reflecting prudent financial management to bolster long-term growth and stability.

Example of Capital Reserve

An Indian IT company sells its old office building for ₹1 crore, originally bought for ₹70 lakhs. The profit of ₹30 lakhs is not from regular business activities but from the asset sale. This profit is allocated to the capital reserve, which can be used for expansion or issuing bonus shares.

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What is Revenue Reserve?

Revenue reserve is a portion of earnings that a company sets aside from its operational profits. This reserve serves multiple purposes, such as supporting dividend payments, financing future expansion projects, or cushioning against unforeseen financial downturns. It represents a company's reinvestment in itself. It enhances its financial health and sustainability without relying on external funding sources, ensuring long-term growth and stability.

Example of Revenue Reserve

An Indian manufacturing company reports an annual profit of ₹50 lakhs. It decides to allocate ₹10 lakhs to the revenue reserve. This fund can be used to finance a new production line, pay dividends during lean periods, or absorb future losses, thus ensuring the company's growth and financial stability in the long term.

Difference Between Capital Reserve and Revenue Reserve

Source: Capital reserves come from non-operational profits (e.g., sale of assets), while revenue reserves are derived from operational profits.

Purpose: Capital reserves are used for expansion or covering capital expenses; revenue reserves fund dividends and operational expansions.

Distribution: Dividends are rarely paid from capital reserves but can be from revenue reserves.

Occurrence: Capital reserves arise from one-time transactions; revenue reserves accumulate from regular business activities.

Nature: Capital reserves are non-recurring; revenue reserves are recurring.

Legal Requirement: Capital reserves may be subject to specific regulations; revenue reserves are more discretionary and flexible.

Conclusion

Capital reserve and revenue reserve serve distinct financial roles within a company. Capital reserve, sourced from non-operational gains, is key for funding long-term investments and strengthening financial stability. In contrast, revenue reserve, derived from operational profits, supports regular business growth and dividend distribution. Understanding these differences is crucial for effective financial planning and resource allocation in any business.

Top FAQs on Difference Between Capital Reserve and Revenue Reserve

What is a Capital Reserve?

Capital reserve is created from capital profits, such as profits from the sale of fixed assets, revaluation of assets, or premiums received on the issue of shares. It is generally used for specific purposes like business expansion or to write off capital expenses.

What is a Revenue Reserve?

Revenue reserve is formed from the profits generated from a company's operational activities. It represents the portion of earnings that is retained in the business after dividends are paid out to shareholders and can be used for any general business purpose, including dividend distribution.

How are Capital Reserves and Revenue Reserves used differently?

Capital reserves are typically used for non-operational purposes such as financing long-term projects, expansion, or strengthening the financial position of the company, whereas revenue reserves are used for operational purposes like funding working capital, paying dividends, or covering future expected losses.

Can Capital Reserve be used for dividend distribution?

Generally, capital reserves are not used to distribute dividends because they are created from non-operational profits. However, there can be exceptions under specific legal frameworks or company policies.

Why is the distinction between Capital Reserve and Revenue Reserve important?

The distinction is important for financial reporting and regulatory compliance, as it affects how funds can be used within the business. It helps stakeholders understand the sources of a company’s profits and how those profits are being reinvested or distributed.

About the Author
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Chanchal Aggarwal
Senior Executive Content

Chanchal is a creative and enthusiastic content creator who enjoys writing research-driven, audience-specific and engaging content. Her curiosity for learning and exploring makes her a suitable writer for a variety ... Read Full Bio