Bad debt expenses are costs incurred by businesses in trying to collect overdue debts, including expenses related to debt collection. Many businesses have a bad debt provision, allowing for uncollected receivables. Tracking bad debt spending helps identify resources devoted to collection activities and can lead to changes in creditworthiness procedures. Tax breaks are available for bad debts, and companies report outstanding balances as bad debt only as a last resort.
Bad debt expenses are any type of expense incurred by a business in an attempt to collect significantly overdue debts. In addition to including the amount of the debt itself, the figure is likely to include expenses related to the debt collection effort. A bad debt expense can involve time and resources spent sending overdue notices, applying late charges to your remaining balance, and any type of charges involved in trying to collect your bad debts through a court system.
Many businesses recognize the potential for a portion of receivables to remain uncollected. For this reason, it’s not unusual for a business to include a section or line item in its accounting records that is known as a bad debt provision. Often, this balance is calculated as a percentage of total outstanding receivables for the cited period. Some companies place specific customer accounts in this category, based on a history of slow payments or news in the business community of impending financial problems for the customer. Allowing for a certain degree of bad debt spending helps minimize the potential for the business to find itself in a cash flow crisis and be unable to meet its debt obligations in a timely manner.
Tracking your bad debt spending is important for several reasons. First, the process allows the company to identify what part of its resources will be devoted to collection activities. This includes staff time, administrative costs and costs associated with outsourced collection activities. When a company discovers that it is spending an excessive amount of money trying to collect a bad debt, it is obvious that changes must be made to the procedures to qualify the creditworthiness of new customers, as well as periodically assessing the credit status of existing clientele.
Another reason to keep track of bad expenses relates to tax breaks. In some countries, federal tax agencies allow businesses to claim a deduction on any bad debts that occur within a specific tax period. This tax break is typically in the form of a percentage of your bad debt or a maximum allowable amount, whichever is less. Depending on the circumstances, the figure may be sufficient to help reduce the company’s overall tax burden, a measure that helps more compensate for the loss the company has suffered due to bad debts.
Companies are generally slow to report outstanding balances on customer accounts as bad debt. The goal is to work with customers with cash flow issues and make payment arrangements that ultimately result in full settlement of accounts. When all reasonable efforts to manage this process have failed, the original balance, any penalties and interest applied to that balance, and all identifiable expenses related to the collection efforts may all be treated as bad expenses.
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