A Revenue Reserve (often called Retained Earnings in the United States) is a company’s piggy bank of accumulated profits. Imagine a business earns $1 million in profit after tax. It might decide to pay out $300,000 to its owners (shareholders) as a dividend and keep the remaining $700,000. This $700,000 is added to the revenue reserve. This reserve is the cumulative total of all the profits the company has earned and kept over its entire history, minus any losses. Crucially, these are distributable profits, meaning the company’s management could legally pay them out to shareholders in the future. This makes them different from a capital reserve, which arises from non-operating activities (like revaluing an asset) and typically cannot be distributed as cash dividends. In short, a revenue reserve is a historical record of a company's success and its decision to reinvest in itself.
Think of a company’s revenue reserve as its financial engine room. For a value investor, analyzing its size and growth trajectory provides critical insights into the health and potential of a business.
A consistently growing revenue reserve is the clearest evidence that a company is profitable over the long term. A business that constantly loses money will have a shrinking or even negative reserve, which is a major red flag. It shows that the company has a durable business model capable of generating more cash than it consumes. This historical profitability is a cornerstone of a sound investment.
These retained profits are not just idle cash; they are the primary source of funding for a company's future. A savvy management team can use this capital to:
A healthy revenue reserve acts as a buffer during tough times. When a recession hits or a company has a bad year, it can dip into these reserves to cover losses, continue investing, or maintain its dividend without having to take on expensive debt or issue new stock (which would dilute your ownership).
You can find the revenue reserve on a company’s balance sheet, which is a snapshot of its financial health at a single point in time. It is a key component listed under the Shareholder's Equity section. Remember, terminology varies. In financial statements prepared under US GAAP (Generally Accepted Accounting Principles), you will almost always see it labeled ‘Retained Earnings’. Under IFRS (International Financial Reporting Standards), more common in Europe, you might see ‘Revenue Reserve’ or ‘Accumulated Profits’. To understand how it changes, you need to look at two other statements:
The basic formula is simple: Ending Revenue Reserve = Starting Revenue Reserve + Net Income - Dividends Paid
For a value investor, the existence of a revenue reserve is just the starting point. The real question is: How well does management use it?
The legendary investor Warren Buffett famously argued that retaining a dollar of profit only makes sense if the company can turn it into more than a dollar of market value for its shareholders. A value investor must act like a detective, examining the company’s history. When management retained profits in the past, did it lead to higher earnings and a stronger business? You can measure this by looking at metrics like Return on Invested Capital (ROIC). High and consistent returns suggest a skillful management team. Low returns suggest they are squandering your potential dividends.
A massive pile of retained earnings isn't always a good thing. If a company has huge reserves but its growth has stalled and its returns are low, it could be a sign of a complacent management team that is hoarding cash instead of either investing it effectively or returning it to its rightful owners—the shareholders. A great business finds opportunities to reinvest its earnings at high rates of return. A mediocre one just lets the cash pile up.