Capital reserves are funds that are set aside for use with specific projects that present a long-term capital investment, or that may be related to some sort of capital expense in the future. It is not unusual for local as well as national governments to create reserves of this type, as a means of incrementally accruing funds for anticipated future needs. A capital reserve may also be established by a company of any size, and be used for ongoing projects or as a means of preparing for some future project.
The main idea behind a capital reserve fund is to set aside assets that are outside the usual operating budget, and can be used to offset expenses with projects that must be funded at least partially outside the operating budget. For example, a municipality may want to build a new city hall. If funds are not set aside in the budget to begin preparation for this activity, then the proceeds from a capital reserve may be withdrawn to manage the costs of preparing a tract of land for the new building, creating blueprints, and in general preparing for the construction of the new facility. Depending on the amount of funds in the capital reserve fund, and the regulations that govern disbursements from that fund, it may be possible to finance the entire construction project using the reserve.
Companies can make use of a capital reserve in much the same manner. The reserve fund can be grown over a number of years, usually by transferring surplus profits generated from time to time into the fund. Should the business wish to expand, possibly by opening a new retail outlet or building a new production facility, the assets contained in the capital reserve can be utilized to launch these projects. Use of the reserves allows the business to manage the process without having to obtain outside financing, and thus eliminates the need to repay interest on loans or lines of credit in order to successfully complete the expansion project.
Any funds that are placed in a capital reserve must be accounted for in the financial records of the municipality or company. For municipalities, this means identifying the origin of any funds deposited into the reserves, including donated funds and funds obtained through government subsidies. Businesses also must accurately account for the origin of any assets assigned to the capital reserve. In many nations, laws govern how a capital reserve must be managed, and provide the basic framework for how a government entity or a business will structure and maintain the reserve, including how the funds are earmarked for specific types of capital expenses.