All corporations need certain equity reserves so that they can still act in the event of economic bottlenecks. However, this reserve may not be shown as subscribed capital , as annual surplus or profit carried forward .
What forms are there and what do you have to consider? What is the difference between reserves and provisions ? You can find out all of this here.
What are reserves?
You need reserves in every company in order to be able to react in emergency situations (repairs, spare parts, spontaneous investments, other unforeseen events). To do this, you have to use part of your winnings and set it aside. This procedure is common in order to be able to use the already taxed profits for unforeseen expenses at short notice.
You have to take into account some legal requirements and accounting requirements, as the amount of the reserves is determined in different companies.
These reserves are a variable part of your company’s equity that you have to book as open reserves (on special accounts) or as hidden reserves (which do not appear on the balance sheet). We will explain more about this in the part about the formation of reserves and the types of reserves.
What do companies need reserves for?
Use for …
- Prevention of losses
- future investments
- later pension payments
- Tax payments
Reserve for future investments
Especially if you run a small business or have just started a business, it is difficult to get money to invest. Since you cannot offer large collateral, especially at the beginning or later with a small business, the banks are very cautious with loans. Therefore, you can put your money aside for the necessary investments and even save tax-deductions in order to be able to afford large purchases for the machine or vehicle fleet (” investment deduction amount “).
In the year in which you put the amount aside, you can list it as a business expense in your financial statements. Even if it means you have to report a loss. As soon as you then make the acquisition and buy the machine or vehicle, you have to book this reserve again as operating income. You don’t have to pay taxes for this amount until you’ve actually made the purchase. However, if you postpone this for too long, the tax office will at some point become skeptical and simply deduct the tax savings and also demand interest from you in the form of a back tax payment. So be careful!
Financing from reserves – self-financing
To keep your company going, you need money regularly to cover your costs. You can finance this self-financing from your reserves. This is also called ” retention of profits “. To do this, you dissolve your retained earnings or your hidden reserves. If you own a sole proprietorship or partnership , you don’t need to separately list these retained earnings, so they add to your equity. For such types of companies, this is often the only way to get current money. With corporations you have to post the profits in the balance sheet under the “retained earnings”, as we saw earlier. Whether you build up the reserves and how high they are is stipulated by law in the case of stock corporations, otherwise the shareholders can also determine it themselves through the articles of association.
How Much Reserves Should You Have?
For private individuals and employees, the rule of thumb is that you should always set aside at least 3 net monthly income – as a nest egg. It’s not that easy with companies. As we have seen, it depends on whether you are required by law to pay a certain amount or whether you can set up voluntary reserves . Therefore, there is no all-inclusive correct sum. So you have to check whether you have to save money for taxes, investments or pensions and then save these sums as well. If you are unsure about this, your tax advisor can give you tips. He has enough experience from various companies and industries and also knows your individual situation. He also helps you with the correct booking and reversal of reserves.
Difference between reserves and provisions
The terms reserves and provisions are often confused with one another because they are often mixed up in daily use and used alternatively. But these are two very different things! The reserves are part of equity . They are formed either according to the requirements of the law or the company statutes (additionally). They are intended to help the company secure future payments and keep dividend payments constant for the next few years. The creation of such a reserve increases your equity without reducing your profit.