Finding your way through the ins and outs of owning your own business can be difficult, but extremely rewarding! Along the way, you will not only find new and interesting ways to create profits, but you also learn a lot about business expenses and debt. Bad debt expense in business is one of those things that can hurt your business, but you may not have any idea what it is until it is too late!

So what exactly is bad debt expense? Much like learning how to calculate the cost of debt, or even learning how to file your taxes properly, bad debt expense is a part of doing business. In order to make that clear to you, here is a breakdown of examples, as well as steps you can take as a business owner to avoid it!

Defining Bad Debt Expense

Unless you’re an accountant or have been in business for years, defining bad debt expense can sound intimidating. However, once you understand exactly what it is, and how it can affect your business, then it’s quite simple!

Your company’s accounts receivable will be where you should be looking for bad debts expense. It can also be called “doubtful accounts expense”, or even “uncollectable accounts expense”. This means that your business has provided goods or services to a customer on credit. Unfortunately, when the time came to collect on that credit, the customer did not pay what was owed.

However, this doesn’t mean you get to just go after the customer for the amount owed legally. Bad debt expense is basically when the customer is no longer able to pay. This is generally due to things like bankruptcy, going out of business, or other unfortunate issues.

How Do You Account for Bad Debt Expense?

Finding how to both report, file and account for bad debt expense in your business finances doesn’t have to be tricky. They are typically sorted as either general administrative expenses, or even as a sales expense. However, bad debt expense does create an obvious obstacle for your accounts receivable!

In addition to losing goods and/or services, your accounts receivable will also be out of balance. Although businesses can always retain the right to collect the amount due if the customer’s financial situation changes, your business is in the red for that account for now.

Two Main Ways to Recognize Bad Debt Expense

Within your company’s financial records, there are two primary ways to acknowledge bad debt expense:

• Allowance Method: This means that your company will take steps to predict this type of expense before it happens. The losses can be calculated into expected income for the year. Therefore, a company can avoid an account overstatement. This can be calculated from previous losses of this kind from the company, as well as from other companies in the same field.
• Direct Write-Off: This is a method of dealing with bad debt expense that is extremely straight forward. Instead of calculating the non-payments into their overall budgets, businesses can write off the expense. All in all, this means that uncollectible funds are written off as a base expense by the business. However, this method can lead to more difficult accounting in the future for many different reasons.

Within your business, how you deal with bad debt expense is completely up to you. Not to mention what is best for the company as a whole.

Avoidance and Modern Business

All things considered, it’s extremely difficult to avoid bad debt expense in the modern business world. When dealing with many different clients, or even different companies, it’s extremely difficult to predict their successes or failures. That being said, there are a few ways to avoid this expense altogether.

As bad debt expense only occurs when dealing with credit for customers, you can simply avoid this expense by not dealing in credit. Simply allow for payments to be made upon receipt of services, or goods.

Because businesses allow customers to receive goods or services on credit, they run the risk of this debt becoming uncollectable! However, this isn’t always a black and white, clear picture kind of decision to make. There are a lot of reasons why you may allow a customer to receive credit from your business, as well as whether or not you aggressively collect those debts.  

Finding Your Way Through Bad Debt Expense

Altogether, owning a business is filled with many ups and downs. From learning how to deal with people one on one, as well as wading your way through corporate takeovers, finding your way through bad debt expense doesn’t have to be a challenge! You can find great ways to collect debts, to deal with clients, but some expenses can’t be avoided.

Overall, how you deal with your bad debt expense is up to you and your business. Whether you prefer the direct write-off method, the allowance method, or trying your hardest to avoid it altogether, there are a variety of paths! However, you can’t predict how well, or how poorly your customers will do. Bad debt expense is simply one of the many, many costs of doing business in the modern, credit-driven world.