September is a period of returning to business activities and reviewing the results achieved throughout the year. For many companies, it is also an excellent opportunity to reassess their financial structure and ensure compliance with legal obligations related to shareholders’ equity.
Among these obligations, the legal reserve stands out as a mechanism designed to strengthen a company’s financial solidity and protect its continuity during periods of economic uncertainty.
At FA ACCOUNTING, we frequently encounter questions regarding how legal reserves work, how they are established, and their importance in corporate management.
In this article, we explain what legal reserves are, when they are mandatory, and the benefits they provide to businesses.
What is a Legal Reserve?
A legal reserve is a portion of a company’s profits that must be retained and incorporated into shareholders’ equity rather than being distributed to shareholders or partners.
Its primary purpose is to provide additional financial protection for the company, enhancing its ability to absorb future losses and contributing to the stability of the business.
Who Is Required to Establish a Legal Reserve?
The creation of a legal reserve is mandatory for commercial companies that generate profits in a given financial year and have not yet reached the legally required reserve threshold.
In general terms, the law requires part of the net profit to be allocated to the legal reserve until it reaches a certain percentage of the company’s share capital.
How Is the Legal Reserve Calculated?
As a general rule, companies must allocate at least 5% of their annual net profit to the legal reserve.
This requirement remains in force until the accumulated reserve reaches at least 20% of the company’s share capital.
Once this minimum threshold has been reached, there is generally no further legal obligation to reinforce the reserve, unless otherwise stated in the company’s articles of association.
What Can the Legal Reserve Be Used For?
The legal reserve cannot be used freely in the same way as other retained earnings or reserves.
Its use is restricted to specific situations, namely:
- Covering losses incurred during the financial year;
- Covering accumulated losses when no other available reserves exist;
- Capitalization into share capital, where legally permitted.
These restrictions ensure that the reserve fulfills its primary purpose of protecting the company’s financial position.
What Are the Benefits of a Legal Reserve?
Although often viewed merely as a legal requirement, the legal reserve offers several important advantages to businesses:
- Strengthening shareholders’ equity;
- Greater capacity to absorb future losses;
- Improved financial stability;
- Enhanced credibility with banks and investors;
- Reduced risk during periods of lower economic activity.
A company with stronger equity capital is generally better prepared to face operational and financial challenges.
The Importance of Proper Profit Allocation
Decisions regarding the allocation of annual profits should be carefully considered by shareholders or partners.
In addition to the legal reserve, it may be necessary to consider:
- Statutory reserves;
- Voluntary reserves;
- Dividend distribution;
- Reinvestment of profits into the business.
A balanced approach allows companies to reward shareholders while simultaneously strengthening their financial position.
Most Common Mistakes Related to Legal Reserves
Some frequently observed situations include:
- Distributing all profits without considering the mandatory allocation to the legal reserve;
- Incorrect accounting records;
- Improper use of reserves;
- Lack of awareness regarding applicable legal limits.
These mistakes can lead to accounting, tax, and corporate governance issues that should be avoided through professional guidance and support.
How Can FA ACCOUNTING Help?
At FA ACCOUNTING, we support businesses in all matters related to accounting and financial management, including:
- Profit allocation analysis;
- Legal reserve establishment and monitoring;
- Compliance with corporate obligations;
- Financial and tax planning;
- Ongoing accounting support.
Protect Your Company’s Financial Stability
📞 Contact us to clarify any questions regarding legal reserves, profit allocation, and the management of your company’s shareholders’ equity.
Disclaimer: This article is for informational purposes only and does not replace professional accounting, legal, or tax advice.
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