Provisions and Bad Debts: Recording Losses Before They Hit

A provision is an amount you set aside for a loss or obligation that is certain to occur but whose exact size you cannot pin down. It rests on the principle of prudence: do not wait for a loss to materialise before you recognise it — recognise it as soon as it becomes probable.

Take credit sales. You know a share of your customers will not pay. Rather than waiting for them to go under before booking the loss, you create a provision that reflects that likelihood today. Your statements become more honest, and you avoid inflating profits that may evaporate later.

The two are widely confused, but the difference is fundamental:

• A provision: a charge against expenses to cover a probable loss (a debt provision, a depreciation provision). It reduces profit.

• A reserve: a slice of profits you have already earned, held back to strengthen the balance sheet or fund expansion — not to absorb a specific loss. It is appropriated after profit has been calculated.

In short, a provision comes before profit and reduces it; a reserve comes after profit and allocates it. Confusing the two distorts how you read your own performance.

When a customer runs badly late, or signs of distress start to show, the debt becomes doubtful to collect — not lost yet, but at risk.

This is where you create a provision for doubtful debts covering an estimated percentage of those receivables, so your statements show that part of your accounts receivable may never come in. The debt stays on the customer's account, but the provision sits against it to reflect a realistic collectible value.

A debt moves from "doubtful" to bad once all hope of collecting it is gone: the customer goes bankrupt, disappears for good, or every legal collection attempt fails.

At that point the debt is written off for real: it is removed from the customer's account and charged against the provision you built earlier (if there is one), or straight to expenses. The distinction from a provision: a provision is an expectation, a write-off is confirmation that the loss actually happened.

A business has accounts receivable of SAR 500,000 and estimates that 4% of it may never be collected:

• Provision for doubtful debts = 4% × 500,000 = SAR 20,000, charged to expenses.

• Net receivables on the balance sheet = 500,000 − 20,000 = SAR 480,000.

If a customer later defaults for good on SAR 7,000, that debt is written off and deducted from the provision — so the new year's profit is not hit by a loss that was already anticipated.

Alongside the debt provision, several others are common:

• A provision for end-of-service gratuity, covering the accumulated obligation to employees.

• An inventory obsolescence provision for slow-moving or expired goods.

• A warranty provision for repairs on products sold under warranty.

• A provision for potential litigation.

All of them apply the same principle: recognise a probable loss when it becomes probable, not when it lands.

Provisions reduce reported profit in the year you create them. That can feel painful, but it protects you:

• It stops you distributing phantom profits that were never really earned.

• It gives investors and banks a realistic picture.

• It prepares the business to absorb the loss when it arrives, without a shock.

Over-providing hides real profits; under-providing inflates fragile ones. Balance and reasonable judgement are the art here.

Snad tracks the ageing of your accounts receivable and flags the overdue balances that are candidates for a provision, so you can size your doubtful-debt provision on real data rather than guesswork.

It also lets you write off hopeless debts and charge them against the provision, and it tracks other provisions such as inventory obsolescence and end-of-service gratuity. Your profitability and receivables end up presented honestly, in line with the principle of prudence, without manual calculations.