Reserve and provision are the two very commonly discussed terminologies in business and commerce. Both of these are actually the amounts of money that a firm keeps aside for saving. In this article, we will understand the complete difference between both these terms. The content of the blog is as follows.
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Definition Of Provision
The provision means to keep aside a particular amount of money from the profit in order to cover up anticipated expenses/liabilities arising in the future or feasible depletion in the value of an asset. Provisions are very crucial for businesses because they address certain liabilities in business and payments made for them. While setting up provisions, an organization recognizes that an obligation will arise in the future, and it will result in an outflow of cash from the business.
Definition Of Reserves
On the other hand, the term reserves refer to a percentage of money(profit) that an organization keeps aside at the end of the financial year in order to meet contingencies that might occur in the future. The sum of the amount in the name of reserves can be used for the given purposes:
- For buying and expanding assets in the future.
- To pay dividends payments to shareholders
- For facing unforeseen contingencies in the future.
The two main types of reserves are:
- Capital Reserves- It is created from capital profits and is not available for dispensation to shareholders in the form of dividends. So, it cannot be made from the profit earned through the core functions of a company.
- Revenue Reserve- The reserve that is created from the profits earned from the core operations of a company or organization is called revenue reserve.
Provision Vs Reserve(Comparison Table)
| Basis For Difference | Provision | Reserve |
| Definition | The provision refers to the portion of money from a business kept aside for meeting known liabilities. | It refers to the part of the profit kept aside for unexpected obligations of the business. |
| Provides | Anticipated liabilities and expenses. | Increase in capital employed. |
| Purpose | It secures a business from expenses arising from known liabilities | Reserves provide capital for running the business and safety against expenses from unexpected contingencies |
| Presence Of Profit | Not compulsory | Profit is compulsory for making reserves. |
| Dividend Payment | Cannot be paid | Paid from reserves |
| Utilization | Provisions can only be utilized for a specific purpose it is created for. | Reserves can be used otherwise. |
Key Differences Between Provision And Reserves
Since we are comparing provision vs reserves with one another, let’s have a look at the key differences between them.
- The provision means to keep aside a particular amount of money from the profit in order to cover up anticipated expenses/liabilities arising in the future or feasible depletion in the value of an asset. On the other hand, the term reserves refer to a percentage of money(profit) that an organization keeps aside at the end of the financial year in order to meet contingencies that might occur in the future.
- While it is impossible to pay off dividends from the provision, the number of reserves can be used to pay a consistent stream of dividends to stakeholders.
- Creating a provision is a compulsory step against the expected liability. On the other hand, the creation of a reserve is a voluntary step except in the case of DRR(Debenture Redemption Reserve) and CRR(Capital Redemption Reserve).
- While the utilization of provision is specific, i.e it must be used for the purpose for which it is created, reserves can be utilized for any given purpose.
- Provision must be created, whether a company earned profit or not. On the other hand, the company must gain a profit for the creation of reserves.
Conclusion
So with the above discussions, we can simply conclude that both provision and reserve have several uses and importance of their own. Both of them, in the long run, decrease the profit of the business. They are important in helping a business to survive against unpredictable future contingencies. Provision must be created, whether a company earned profit or not. On the other hand, the company must gain a profit for the creation of reserves.
