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The share capital of a limited company is regarded as a buffer fund for creditors. (Note that the creditors’ buffer is an accounting fund, not real money. The actual cash or assets subscribed can be used by the company.)
What do u mean by the sentences in the brackets that creditors buffer is fund and not money etc and etc plz explain mike
First of all, it’s not just the share capital that comprises the buffer fund. Also to be included are the undistributable reserves! Share Premium account, Revaluation Reserve, Capital Redemption Reserve plus any reserve identified by the company’s articles as being undistributable
This means that, as these above accounts are increased, so also are the net assets increased and the company gets stronger. But the company is able to use those net assets to carry on its business
What it cannot do is use assets such that they fall in total to an amount lower than the buffer fund. Therefore it cannot pay out excessive cash by way of dividend because that would potentially result in a position where net assets were lower than the buffer fund.
But now we have a problem! What happens when the company has a string of losses that results in a huge deficit on the Retained Earnings. Buffer fund less retained earnings = net assets and now those net assets are clearly below the buffer fund! But you cannot legislate against companies making losses!
In answer to your specific question, the net assets are available for use by a company in order that it can carry on its normal business activities
Does that do it for you?
The buffer fund is an expression that tells us that net assets shall not fall below a certain figure. It’s not a fund of “cash” so it’s not a fund that is double entered in some bank account that cannot be touched / distributed. It’s simply the title that is given to the accumulation of a number of accounts (listed in one of my previous responses) and is protected in terms of the fact that net assets shall not fall below that aggregated value.
Think about it! You’re original email question said that the buffer fund is the share capital. Now I have already pointed out that the buffer fund is more than just share capital but let’s assume that you are correct and forget all these other elements for a moment.
Say the company wants to pay a dividend. Can it take some of the share capital and say to its shareholders “Here you are, guys. Here’s a part of our share capital that you can go and spend at the cinema. So the shareholders take this piece of share capital and go down to their local Roxy cinema and say to the lady on reception “I’m sorry but I have no cash. However, I DO have this piece of share capital so will you take this instead?”
You go to the local butcher and ask for some sausages. He counts them and weighs them and says “That will be $10 please Rishabh” to which you say “I’m sorry but I have no cash. However, I DO have this piece of share capital so will you take this instead?”
Do you see where I’m going with this? It ISN’T CASH!
If you carried on with your journey into the local shops and went through this conversation, it wouldn’t be long before men in white coats appeared and took you kicking and screaming to the local mental hospital. But, hey, that wouldn’t matter because you could always buy your way out by bribing one of the security staff with the offer of some piece of the share capital that you still have in your pocket (except that you wouldn’t wish to sink to the level of the criminal offence of bribery!)
Well, if it’s not cash, what is it?
It’s a title that is given to the aggregation of the balances on specified accounts within the ledger system of a company and it’s represented by Intangible, Tangible and Current assets less Long Term and Short Term Liabilities.
In fact, it may be the case that the company actually has no money and instead has an overdraft at the bank. But it still has a buffer fund
Does that make it any clearer?
Mike u said “This means that, as these above accounts are increased, so also are the net assets increased and the company gets stronger.” How does it make stronger . increasing share capital or capital redemption reserve does not strengthen the company and when the revaluation of asset takes place they will not increase or decrease the value of asset as I read it is done on accumulated basis that is when it is realized or u can say sell , dispose , purchase etc . So how will it strengthen ? Plz explain
A revaluation is surely just a way of recognising the increase in the value of an asset (the profit gained on the holding of an asset) in advance of it being sold at a profit at which stage the company’s distributable reserves will increase by the value of that released revaluation reserve.
Is it too difficult to appreciate that a company that has a large buffer fund is rather stronger than a smaller company with a much lower buffer fund?
That line of mine in my previous email is not strictly correct:
“It’s a title that is given to the aggregation of the balances on specified accounts within the ledger system of a company and it’s represented by Intangible, Tangible and Current assets less Long Term and Short Term Liabilities.” because, of course, Retained Earnings and other distributable reserves also are represented by those net assets.
But you should get the general drift of the idea that the buffer fund is an amalgamation simply to ensure that there will be net assets available for distribution to, and full payment of, the company’s obligations
OK?
Mike is said “What it cannot do is use assets such that they fall in total to an amount lower than the buffer fund. Therefore it cannot pay out excessive cash by way of dividend because that would potentially result in a position where net assets were lower than the buffer fund”. I have read that these restrictions are only for private companies
That is only partially correct! There’s an extra bit of rules applicable to public companies that isn’t applicable to private companies.
For a private company, the calculation of the buffer fund is “Share capital plus undistributable reserves”. For a public company, the calculation is “Share capital plus undistributable reserves plus provisions (included within obligations)”
That’s an improbable question that may possibly be asked!
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