Be Sure To Track Uncollectable Balances and Bad Debt

Thursday, March 18, 2021

The challenging economic environment continues to be fueled by the pandemic, and has left many businesses holding “bad debt” in the form of payments owed that will never be collected from customers. Why should a business manager worry about bad debt? The balance sheet is an accurate and fair indicator of the company’s financial position on a given day at the end of the financial reporting period and the balance sheet must be adjusted to reflect the impact of bad debts. How much should a company hold relative to their revenue? Let’s discuss some strategies you can use to keep uncollectable balances and bad debt as low as possible.

  1. Look for warning signs: You should assume that due to the pandemic and the hardships it has imposed on both businesses as well as individuals that uncollectable balances will pop up. The key is to not let them spiral out of control. Benchmark internally and track your numbers over time. How many uncollectables were there 30/60/90 days ago? Over time they could turn into bad debt.
  2. Examine your revenue-to-cash ratio: If your sales are a million dollars a month, ideally the cash flowing in during the subsequent period should be around 80%. If less, look for where the gap might be.
  3. Know your customers, and how flexible you can be with them: Are they in the hospitality industry or other industry hard hit by COVID? They might truly have challenges paying on time. Talk to them, be ready to extend terms, take a percentage. Don’t sacrifice your bottom line, but it may be worth agreeing to extended payment terms for important and strategic customer relationships, even if COVID means accepting slower or lower payments while they ride out the crisis.
  4. Revisit your credit policies: You may have to tighten your credit policies. Generally, with items over 120 days it becomes more unlikely you will collect, you may have to write off that bad debt, accordingly.
  5. Be proactive about bringing in cash:
  • Train your staff to prioritize accounts for collection, how to work with customers in difficulty, and identify those deserving of extended payment terms.
  • Require a deposit, often it is more likely the customer will pay the balance.
  • Offer “early pay” discounts!
  • Leverage credit holds till customers pay their balance.
  • Look into a customer pay portal, it facilitates customer payments.

Uncollectable balances represent money you won’t get for a service or product you’ve already delivered. With many areas of the country still battered by the pandemic, a portion of uncollectable balances should be expected at this time. It’s more important than ever to monitor, measure and track the trend, to work with customers to recover whatever you can in order to keep your own boat afloat.

Remember, a business-related bad debt is a deductible item when filing the business income tax returns, but the federal government allows this deduction only if it was previously included in the gross income while filing the taxes. It can be claimed as an operating loss and can be subtracted from gross profits as a tax deduction, but if the books of accounts are maintained on a cash basis, bad debts cannot be claimed as a deduction, as all income is recognized only when received in cash.

Reach Out To Us: Some companies in today’s economic environment are struggling to keep their business above water or to continue making their payroll. You are not alone – we are here to help! A good finance manager should know when their company is holding too much bad debt. Let us help you recognize if trouble is on the way, and devise solutions to limit the amount of uncollectables and recognize red flags before it gets too late. Call 855-542-7537 or email CPA@fuoco.com.