Bad Debt Expense 101: What It Is And How To Calculate It

The majority of entrepreneurs understand that bad debt is part of doing business, and it can’t be avoided. But unsavvy and careless entrepreneurs that encounter their first case of bad debt may need to mitigate the damage by taking out a loan themselves to cover their financial obligations. 

From Receivable To Bad Debt: A Timeline

The best way to understand how an unpaid bill is determined to be bad debt is through an example of a potential timeline.

Suppose a business owner agrees to sell a $10,000 product on 2/10 net 30 terms. This means the client has ten days to pay the bill to take advantage of a 2% discount. Otherwise, the full amount is due within 30 days.

Why Businesses Take A Chance

A common question many ask at this point is, why would a business give away their product or service with no upfront payment? Many Business-To-Consumer (B2C) companies are likely to run some form of a credit check in advance, so they have a higher degree of confidence in the customers’ ability to pay their bills.

Easy To Calculate Bad Debt

Any business owner that took the time and effort to maintain an up-to-date account of their business can easily calculate the percentage of bad debt over a given period. The method consists of dividing the total amount of bad debt by the total accounts receivable for a given period.

Business owners must account for eventual bad debt through a commonly known accounting principle known as the allowance method. This method assigns an estimated dollar amount of uncollectible bills in the same period in which sales are recorded. 

How To Account For Bad Debt

Bad debt expense is a fact of doing business but properly accounting for and managing it is often beyond a business owner’s knowledge. This is why it is crucial for business owners to have good relationships with tax advisors and credit advisors. 

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