Importance of Reserves
A business firm may think it appropriate to set up some mechanism to protect it from the consequences of unknown expenses and losses; it may be required to bear in future. It may also consider reducing the amount that can be drawn by the proprietors as profit in order to conserve business resource to meet certain significant demands in future.
An example of such a demand is the much needed expansion in the scale of business operations. This is presented as the justification for reserves in business activities and in accounting. The amount so set aside may be meant for the purpose of:
- Meeting a future contingency
- Strengthening the general financial position of the business;
- Redeeming a long-term liability like debentures, etc.