Why is HUL transferring general reserves balance to P&L account

June 6, 2016:  

 On June 30, the shareholders in Hindustan Unilever Ltd (HUL) will vote on a proposal that is a first in corporate India.

HUL is proposing to transfer the entire balance lying in its General Reserves as on April 1, 2015 (about ₹2,187 crore) to its profit and loss (P&L) Account.

This, the company says, will give it greater flexibility to enable, among other things, payouts to its

members.

Simply put, the move will give the company greater freedom to distribute dividends to its shareholders.

The rationale

This unique proposal, approved by HUL’s board of directors in January, needs the assent of at least three-fourth of the shareholders voting on it.

HUL has grown profits consistently, has zero debt, a strong dividend paying record (payout ratio of 85-101 per cent in the past three years), robust cash generation from operations (more than ₹5,000 crore annually for the past three years), healthy cash balance (about ₹5,000 crore as of March 2016), and accumulated reserves in excess of its planned spends.

Given this, returning the excess can help the company reward its shareholders, and at the same time, further improve profitability metrics such as return on equity.

A hefty dividend payout would have been constrained by the significant balance in the company’s general reserves, built over the years by transfer of retained earnings, as payment of dividends out of general reserves is subject to restrictions.

Says Sumit Naib, Director at Nangia & Co, Chartered Accountants, “One, the rate of such dividend should not exceed the average dividend rate of the past three years.

Two, the amount shall not exceed a tenth of the paid-up capital and free reserves. Three, losses incurred by the company should be first set off. Four, the reserves after such dividend, shall not fall below 15 per cent of the paid-up capital.”

There are no such restrictions to declaring dividends out of the balance in the P&L account. Concurs CA Surendra Agrawal, “If a company declares dividends out of profits, it can do so without any restrictions. But it will have to fulfil certain conditions, if it declares dividends from reserves.”

HUL’s move to shift the balance in the general reserves to the P&L account, thus, seeks to give the company the leeway to give dividends without fetters.

As of April 1, 2015, the balance in the company’s general reserve was ₹2,187.33 crore, while that in the P&L account was ₹1,177.09 crore.HUL’s move to transfer the balance from the general reserve to the P&L account has been made possible by changes introduced by the Companies Act, 2013. Unlike earlier, there is now no compulsion for companies to transfer a certain percentage of profits to its reserves before declaration of dividends.

Instead, Section 123 of the Companies Act, 2013, leaves such transfers to the discretion of companies. Making use of this change, HUL did not transfer any sum from the P&L account to general reserve in fiscals 2015 and 2016.

Now, it is going a step further and reversing the earlier transfers.

 The proposal should sail through at the shareholder meeting; promoter Unilever PLC and its associates hold more than 67 per cent of the shares of HUL. They will be the largest beneficiary of the dividend largesse that can be expected from HUL in the coming quarters.