Understanding company finance can be complex, but some concepts are essential for anyone involved in business. One such concept is the Capital Redemption Reserve (CRR). So, what is mean by Capital Redemption Reserve? It’s a crucial element in maintaining a company’s financial stability when it buys back its own shares.
Decoding the Capital Redemption Reserve
What is mean by Capital Redemption Reserve in practice? The Capital Redemption Reserve is an account created by a company when it redeems (buys back) its own shares. When a company buys back its shares, it reduces its share capital. To ensure that the interests of creditors and other shareholders are protected, the law requires the company to create a reserve equal to the nominal value of the shares redeemed. This reserve restricts the amount of profits that can be distributed as dividends, thus conserving the company’s assets.
Here’s a further breakdown of why the CRR is important and how it functions:
- The CRR can only be used for specific purposes, such as issuing fully paid bonus shares to existing shareholders.
- The creation of CRR ensures that the company retains sufficient funds to meet its obligations.
- By restricting dividend payouts, the CRR contributes to the financial health of the company.
Ultimately, this provides assurance to creditors that the company’s solvency isn’t compromised by the share buyback. In simple words, the CRR acts like a safety net, making sure the company can still pay its bills after buying back its shares.
Let’s consider how the CRR is funded. The money to establish the CRR comes from profits that are available for dividends or from the proceeds of a fresh issue of shares made specifically for the redemption. It cannot be funded by revaluation profits or any other unrealized gains. Here is a summary:
| Source of Funds for CRR | Permitted? |
|---|---|
| Profits Available for Dividends | Yes |
| Fresh Issue of Shares (for Redemption) | Yes |
| Revaluation Profits | No |
Ready to delve deeper into company finance? Explore Investopedia for a wealth of information and practical examples to solidify your understanding of the Capital Redemption Reserve and other essential financial concepts.