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Bad Debt Expense and Ways to Deal With It

Year 2022
August 2022
Bad Debt Expense and Ways to Deal With It
09 Aug 2022

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Without powerful financial management tools to manage their finances such as ERP software, companies usually face risks coming from loans and credits. A typical reality for businesses that provide credit to customers is bad debt. In today’s article, we would shed light on the nature of bad debt expense and suggest ways to eliminate it. 

1. Recognising a Bad Debt Expense: Bad Debt Write-off vs Bad Debt Provision

Bad debt arises when a customer either refuses to pay, or is no longer able to pay an outstanding debt due to bankruptcy or other financial issues.  A bad debt expense refers to an uncollectible receivable.

To ensure that investors can see all of your accounts are in good health, it is crucial to categorise bad debts. There are two main techniques when it comes to bad debt recognition: the direct write-off and the allowance/provision method.       

Bad Debt Write-off                                            

The direct write-off method is employed when you have a definite and recognisable bad debt on your accounts or when you are aware that clients can not pay back the debt. In this method, the amount of the write-off is debited from the bad debt cost and credited to the accounts receivable as it becomes uncollectible. 

The direct write-off approach does not, however, adhere to the matching principle used in accrual accounting and generally accepted accounting principles (GAAP). Even if it records the precise amount of uncollectible principle, expenses and corresponding revenues must be matchy during the same accounting period as the revenue transaction. 

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As a result, the allowance technique, which provides an estimated dollar amount of uncollectible accounts in the same period that produces the revenue, is to calculate bad debt expenses. 

Bad Debt Provision/ Allowance

A bad debt provision is a type of accounting used to include projected losses in your financial statements to prevent overstating possible income. A company will predict how much of its sales-related receivables will be overdue in order to avoid an overstatement in the account. 

Contrary to the direct write-off method, the allowance technique merely estimates the amount of money that will not be recovered. It is because there is no significant amount of time passed since the transaction. Consequently, a provision for doubtful accounts is set up through the accounts receivable aging method or the percentage of sales method. 

2. Estimating a Bad Debt Expense

There are two typical methods used to estimate the amount of uncollectible receivables (Investopedia).

The first technique uses statistical modeling, such as default probability to calculate predicted losses from delinquent and bad debt. The statistical calculations can make use of past information from both the company and the industry as well. The specific percentage will normally rise as the receivable’s age rises, hence reflecting rising failure risk and declining collectibility. 

The second one will base on the business’s prior history of bad debt. By taking a proportion of net sales, businesses are able to calculate a bad debt expense.

Accounts Receivable Ageing Method

The accounts receivable ageing method groups the receivable accounts according to their age. And it also marks a percentage based on how likely they are to be collected. This percentage is estimated based on a company’s historical collection. 

To calculate the amount of bad debt expense, the estimated percentages are multiplied by the total amount of receivables for that time period and aggregated together.  

You can see an example of account receivable ageing method in the table below.

Age of Receivable <30 days 30-60 days 61-90 days >91 days
% Not Collected 2% 5% 12% 35%
Total Receivables $100,000 $3,000 $7,000 $2,000
Estimation of Uncollected Amount 2,000 150 840 700
Total Bad Debts


Percentage of Sales Method

The percentage of Sales method multiples the total sale values by an estimated percentage based on the company’s historical experience with collecting receivables.  For instance, if a company’s sale is $3,000,000 and 5% of this volume is about to be irrecoverable, their bad debt expense would be $3,000,000 * 5% = $150,000. 

3. Importance of Bad Debt Expense

Almost every business may encounter a customer who is unable to pay at some point, and they will need to report a bad debt expense timely and accurately. It enables businesses to thoroughly and accurately present their financial status. 

Moreover, it can help companies identify doubtful customers who have fallen behind on payments so they can avoid the same credit fraud scenarios in the future. 

4. Compete Risk Free with Synergix Financial Management

Being one of the leading ERP providers in Singapore, Synergix Technologies offers a fully integrated, cloud-based and customisable ERP system with various modules including finance industry. To help your business effectively manage its finance while still complying with IRAS regulations, Synergix Financial Management ERP solution provides powerful financial management tools equipped with multiple features such as: 

  • Managing your receivables for quicker cash flows
  • Rationalising your financial views through flexible segment analysis
  • Crediting terms control and alerting for uncompromised cash inflow
  • Performing quick adjustments with contra entries

And many more innovative solutions for your business’s financial view. 

With decades of experience in developing ERP solutions, Synergix Financial Management will definitely be an effective safeguard against bad debt and provide you with confidence to trade. Additionally, eligible enterprises can claim up to 70% of the qualifying cost when adopting Synergix ERP system.

Ready to elevate your business’s financial status? Feel free to contact our consultants now!

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