It refers to the reinvestments by concern of its surplus earnings in its business. And is an internal source of finance. It is the cost free source of finance, gains confidence of the public and there is no dilution of control. A part of the profits is kept for future emergencies, and reserves are created out of such undistributed profits. Reserves may be created for specific purpose or they may be kept as General Reserves. Sometimes the reserves are invested outside the company or sometimes general reserves are reinvested in the business of the company by converting them into bonus shares.
But excessive resort to ploughing back of profits may lead to monopolies, misuse of funds, over capitalization and speculation etc. Companies generally keep a certain percentage of profit after tax for self financing. The percentage of retained earnings varies from company to company and from period to period.
