Provision vs. reserve
Two terms that change the reading of a balance sheet.
By Amr Adel
Two terms that change the reading of a balance sheet.
Provisions and reserves are often confused because both reduce what seems available to distribute. They are, however, very different things.
A provision is an obligation
A provision recognises a liability whose timing or amount is uncertain: a legal claim, a warranty, an end-of-service benefit. It is an expense in the income statement and a liability on the balance sheet.
A reserve is part of equity
A reserve is an allocation of profits already earned, kept within equity: a legal reserve required by law, or a general reserve decided by the shareholders. It is not an expense and it is not owed to anyone.
Why it changes the reading
- Under-provisioning inflates profit and hides future cash outflows
- Large reserves signal retained strength, not hidden costs
- Analysts should read provision notes as carefully as the main statements
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