Term
Funds created from profit
Parts of equity built from net profit, such as the reserve fund, statutory funds under the articles or a bonus fund. The law or the general meeting decides how they are created and used, and they limit what can be distributed to shareholders.
Updated
What it means
Funds created from profit are parts of equity built from net profit, such as the reserve fund, statutory funds under the articles or a bonus fund. The law, the articles or the general meeting decide on their creation and use when deciding on profit distribution.
Unlike capital funds, which arise from shareholder contributions or revaluation, funds from profit are created out of the company's results. Their purpose is to strengthen stability, build a buffer to cover losses or set money aside for a specific purpose.
Funds from profit limit what can be paid out to shareholders. The reserve fund generally cannot be distributed and serves mainly to cover losses, while other funds may be used only for the purpose set out in the articles or a general meeting resolution.
How it works in practice
When approving the financial statements, the general meeting decides how much profit goes to funds, how much is paid as dividends and how much remains as retained earnings. Where the law or the articles require a reserve fund, the allocation takes priority over payouts.
The social fund is a special case: it is created compulsorily as an expense based on wages and voluntarily also from profit. It is used for contributions to employees, such as meals, transport, recreation or recovery, under a collective agreement or internal policy.
In the accounts, allocations to funds from profit are recorded within equity and are not expenses. Use of the funds must match their purpose, and in an audit it must be shown that the relevant company body approved the spending.
What to watch out for
Before paying shareholders from funds, check that the law and the articles allow it and carry out the solvency test. An unlawful payout may have to be returned and can make directors liable.
Funds from profit are not cash in the bank but an equity line in the accounts. A company can have a large reserve fund and little cash at the same time, so its ability to pay is shown by cash flow, not the size of its funds.
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