Bad Debt Provision

A bad debt provision - sometimes called a provision for doubtful debts - is an accounting entry that reduces the reported value of your accounts receivable by the amount you estimate may never be collected. Rather than waiting until a debt is formally confirmed as unrecoverable, the provision records the potential loss in the same financial period as the original sale. This keeps your balance sheet accurate and matches the cost of non-payment to the revenue it relates to.

For small and medium-sized businesses in project-based or service industries, building a bad debt provision into year-end accounts is a practical way to present realistic financials to lenders, directors, or investors - and to flag deteriorating credit risk before it becomes a cash flow problem.

How a Bad Debt Provision Works in Practice

A provision is typically calculated in one of two ways: as a general percentage applied to total outstanding receivables, or as a specific allowance against individual customer balances that are showing signs of difficulty.

The accounting treatment debits a bad debt expense account - reducing profit - and credits a provision for doubtful debts account, which reduces the receivables balance shown on the balance sheet. If the debt is later recovered, the entry is reversed. If it becomes confirmed as unrecoverable, it is formally written off against the existing provision rather than hitting the profit and loss account again.

Bad Debt Provision vs. Write-Off

A provision and a write-off serve different purposes, though both reduce the reported value of a receivable.

A provision is an estimate made while you still expect some recovery, or while the situation remains unresolved. The debt stays on the books, adjusted by the provision balance. A write-off is final: the debt is removed from accounts receivable entirely because recovery is no longer expected.

For UK tax purposes, the distinction matters. HMRC generally requires a debt to be genuinely bad - not just overdue - before a write-off qualifies as a deductible trading expense. A provision for doubtful debts may or may not be allowable depending on how it is calculated and documented. Businesses should confirm the tax treatment with their accountant before making a claim.

Maintaining accurate invoice records and aged debt reports makes it straightforward to identify which customer balances are overdue and by how long - the basic data your accountant needs to calculate or review your provision at year-end.