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General reserve has a deep meaning and value in accounting and business. The flow of business is hampered by various inevitable risk factors that can bring a significant downfall in the revenue generation capacity of an organisation. In such cases, creating a reserve for general category purposes is the main point of consideration.
It ensures that a specific amount from the total profit generated by the organisation will be preserved to cope with uncertainties. In this way, a company can continue its regular work without being severely affected. It provides stability and security so that the company can look forward to greater growth opportunities.
Features of general reserve
General reserves contain a specific amount from the total revenue or profit generated by the company. The company might first provide a basic salary to its employees and then set aside a specific percentage from the remaining value as a contribution towards the general Reserve.
The other method is to set aside a specific percentage from the total revenue or profit generated and then distribute salary to the employees. There is a fixed amount that a company reserves for future emergencies.
The fixed amount as a reserve can be used in case of any losses.
It can be used to increase its territory, for acquisition or any other form of growth and development.
It provides a sense of security and consistency on which the company can rely.
It helps to cope with unknown liabilities or to increase assets.
It helps improve liquidity or pay the liquidity damage.
It helps balance the dividend rate in a company in the absence of a reservation strategy for that.
It balances the profit and overestimation in finance accounting to ensure proper workflow.
It is a part of the revenue reserve that most companies earmark before distributing their total revenue generated.
It can be used as a medium to increase the number of shareholders that will help the company to expand its market.
Perks of general reserve
The general reserve has meaning and value in the corporate world as it deals with stabilising the financial status of a company in case of any future urgency. In such times, a company must have financial backup to handle the situation without much pressure or damage to its work. A company has numerous advantages of maintaining general reserves. Some of these are:
It provides financial support and strength and ensures that the company can handle any financial crisis.
It enhances the prospects by increasing the efficiency and productivity of the employees as they have a sense of security.
It helps cope with any future loss, financial instability or liquidity damage.
It provides financial support if the company wants to increase its working area, acquire assets or enhance infrastructure.
It reduces dependency on other organisations or banks for a loan to expand or increase its projects.
Limitations of having a general reserve
General reserves are not a mandatory reserve strategy, and a company can decide on its necessity and suitability. Various companies rely on specific reserves rather than general reserves because specific reserves have a good and fixed percentage of total profit or revenue earned by the company.
It ensures that the company will have a fixed amount that can be used to meet uncertain or beneficial future requirements. Apart from this, a general reserve has some limitations that hinder its application. These include:
As a fixed amount from the total revenue needs to be reserved, the current projects can face some assets or liability management issues. It can result in a reduced resource allocation that can increase the project’s development lifecycle.
As a ratio of total revenue is separated at the beginning, the actual progress cannot be evaluated. It might have minute errors as the represented figure will be less than the obtained one.
It has no description or purpose mentioned. Hence, it can cause mismanagement in financial reports when it comes to reasoning and categorising funds generated and reserved.
It can lead to false market information by providing declining statistics even if the company is making profits.
The dividend rate is reduced as a fixed profit amount is reserved and cannot be used until specified.
Hence, there should be a balance between the risks and perks of reserving a fixed amount. If the perks dominate and the associated risks are negligible, only then can a company go for general reserve.
Calculating general reserve
The calculation of general reserve involves basic arithmetic operations.
Let us take a company ABC that has generated total revenue of $30,000 for a particular year.
It has specified that 20% of this generated revenue will be reserved. Hence, this gives 30000*0.2 as the reserved amount.
Therefore, the total reserved amount is $6,000
Conclusion
Regarding general reserve, there are specific things that a company needs to consider before it reserves a part of its total profit. According to requirements, the percentage of total revenue stored as a general reserve can change from time to time as there are no specific rules or criteria to define general reserves.
A company can set this based on convenience, profits and other factors so that there is no setback due to lack of resources. Sometimes, fixed or specific reserves are more beneficial, especially for an MNC with numerous fund sources.
