What is bad debts?

Bad debts refer to money that is owed to a company by a customer or client that is unlikely to be paid back. This can occur when a customer goes bankrupt, is unable to pay their debts, or simply refuses to pay. Bad debts are typically written off as a loss by the company and can have a negative impact on their financial health.

Bad debts are accounts receivable that are considered unlikely to be collected. They are typically written off as a loss on the income statement.

Causes of bad debts:

- Customer bankruptcy
- Customer insolvency
- Customer disputes
- Uncollectible accounts receivable

Consequences of bad debts:

- Reduced profits
- Increased expenses
- Impaired cash flow
- Damaged business reputation

Preventing bad debts:

- Credit checks on new customers
- Clear payment terms and conditions
- Regular invoicing and follow-up
- Credit limits and monitoring
- Credit insurance

Accounting for bad debts:

- Direct write-off method: Bad debts are written off as expenses when they are deemed uncollectible.
- Allowance method: A reserve for bad debts is created on the balance sheet to estimate future bad debt losses.

Importance of managing bad debts:

Managing bad debts is crucial for businesses to:

- Maintain a healthy balance sheet
- Improve profitability
- Enhance cash flow
- Protect business reputation