You must predict the future, yet the future is not reliably predictable.

The difficulty of predicting the future even a few years ahead. 

An unresolvable contradiction exists: to perform present value analysis, you must predict the future, yet the future is not reliably predictable. 

The miserable failure in 1990 of highly leveraged companies such as Southland Corporation and Interco, Inc., to meet their own allegedly reasonable projections made just a few years earlier-in both cases underperforming by more than 50 percent-highlights the difficulty of predicting the future even a few years ahead. 

Investors are often overly optimistic in their assessment of the future. 

A good example of this is the common response to corporate write-offs. This accounting practice enables a company at its sole discretion to clean house, instantaneously ridding itself of underperforming assets, uncollectible receivables, bad loans, and the costs incurred in any corporate restructuring accompanying the write-off. 

Typically such moves are enthusiastically greeted by Wall Street analysts and investors alike; post-write-off the company generally reports a higher return on equity and better profit margins. Such improved results are then projected into the future, justifying a higher stock market valuation. 

Investors, however, should not so generously allow the slate to be wiped clean. When historical mistakes are erased, it is too easy to view the past as error free. It is then only a small additional step to project this error-free past forward into the future, making the improbable forecast that no currently profitable operation will go sour and that no poor investments will ever again be made. 

How do value investors deal with the analytical necessity to predict the unpredictable? 

The only answer is conservatism. 

Since all projections are subject to error, optimistic ones tend to place investors on a precarious limb. Virtually everything must go right, or losses may be sustained. 

Conservative forecasts can be more easily met or even exceeded. 

Investors are well advised to make only conservative projections and then invest only at a substantial discount from the valuations derived therefrom.

What are provisions in accounting?

A provision is accounting for a future expected loss.

Some examples of provisions are:

• Car companies will establish a warranty provision - on the basis that cars sold with a warranty may need to be fixed.
• If a company is being sued, and there is a reasonable expectation that they will lose the case, they may need to raise a provision.

The provisions merely book the loss in the current period (or the existence of the provision shows that the loss has been accounted for).  

It does not reflect whether or not any money has been set aside to pay out costs.

A provision for non-payment of an amount owed (called a provision for bad and doubtful debts) merely reduces the asset (debtor) and appears as a loss in the P&L account - this is booked in the period in which the debtor is expected not to pay.

When it becomes clear that they will definitely not pay, the amount is written off as a bad debt - note, it has already hit the P&L account when it was provided for, so writing off a bad debt that has already been provided for has no further impact on the P&L account.

Taking a Hit - Accounting Write Off or Write Down

Corporate accountants write off or write down items under several sets of circumstances.

• They may write a debt off the books that they are convinced will never be collected.
• They may mark down the value of an asset that is no longer worth what it once was.

Excessive write-offs in one year can, in some circumstances, lead to greater than normal profits in the next.  It is an old management trick to take all write-offs or write-down during a period when earnings aren't looking so good anyway.  

• The company decides to load all the bad news into one accounting period rather than several fairly bad ones, but the contrast between the bad quarter or year and the subsequent good one appears dramatic.
• This jump in earnings thrills the investing public (the company did lousy last year, but look how it's come around!)  But again, the better earnings may turn out to be a  brief aberration.  The following year the company's earnings fall back into the old ways.

Yet done frankly and for the right reasons, write-downs may lead to real and long-lasting improvement in earnings.  

• They make a difference when the company is saying:  "This was a problem; we've faced up to it.  The adjustment will allow the income statement to accurately reflect the condition of our company in the years ahead."

For alert investors, losses or gains that result from a single episode can be a boon.

• If other investors overreact to the news in either a positive or negative way, it may create a chance to buy or sell at an advantageous price.