The Potential Impact of Bad Debt on Your Business

Posted 22 April by Blaine Bertsch in Accounting, Bookkeeping, Cash Flow

Understanding bad debt and the impact of business write-offs. 

Bad debt can negatively impact a business, making continuation or even just survival very difficult. 

Businesses must make sure they do all they can to reduce their exposure to bad debt. Below we will explore what constitutes a bad debt and how businesses can reduce their exposure.

Specifically, we’ll cover how to technically write off bad debt in QBO, Xero, Sage Intacct and how to reverse bad debt write-offs. 

But first we need to understand what is a bad debt. 

Bad debts are when a borrower or client owes you money for goods or services you provided, but you can’t collect it. You therefore write it off and this affects your bottom line. In most cases a bad debt occurs when you have extended credit terms to an unsuitable customer or when the customer’s circumstances change.

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One of the most obvious consequences of experiencing a bad debt is that a business’ cash flow is disrupted, resulting in lowered profitability. Consequently, the investment plans of businesses that have experienced bad debt can become delayed. With the absolute worst-case scenario for businesses that are victims of bad debt being insolvency. 

How to avoid bad debt. 

Obviously, no one can predict the future, but there are many steps that can be taken by businesses to avoid bad debt in the first place. 

  1. Do your due diligence

Receiving your prospective customers’ credit information is essential to reducing your business’s risk of bad debt. Ultimately, the results of a credit check will let you decide whether or not you should work with another business, customer, or partner.

  1. Implement effective credit control

A good credit control strategy will drastically reduce your risk of bad debt, proactively track and collect payments after they are due, suggest alternatives (if necessary), and ensure your credit control team has expertise in dispute resolution techniques.

  1. Protective measures against bad debt  

Businesses who are looking to protect themselves from the dangers of bad debt need a bad debt protection service. 

Writing off bad debt in QBO, Xero, Sage, and Intacct

In your online accounting software, writing off bad debt will be a similar process no matter what program you’re using. 

Once it is clear a business or client cannot/will not pay, after checking your accounts receivable, you will simply create a bad debt account under your “expenses”. You will then create a new expense item and the expense will be removed from AR and instead itemized in bad debts. 

You’ll want to create a credit memo on the customer’s account and will indicate that it is a write off in the “income amount” section of the client account. You’ll also apply the bad debt credit memo to the associated payment/invoice record for that client. The uncollectible receivable is now listed in the Bad Debts expense account in your Profit and Loss report.

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How to reverse bad debt write-offs

When you receive the payment on a bad debt you wrote off (yay!), you must reverse the bad debt write-off entry. Increase the account receivable account with a debit and decrease the bad debt expense account with a credit to reverse the write-off entry, if the payment is received within the same tax year. Record the payment transaction as a debit on cash and as a credit on receivable accounts.

For example, if a client pays you 75 days after you wrote off their invoice, you would reverse the journal entry and indicate:

Accounts Receivable – Debit $100

Bad Debts Expense – Credit $100

Record the payment like this:

Cash – Debit $100

Accounts Receivable – Credit $100

Now hopefully you never have to experience bad debt, but if you do, it is a lot nicer to be reversing these debts than writing them off. It’s a little tricky when it comes to the accounting side of things, but that is why we have created advanced software capable of forecasting potential bad debt and its impact on your cash flow. 

If you are interested in finding the best services to ensure that your bad debt risk is kept to a minimum, contact our team at Dryrun today to find out how our software can support your business.

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