Bad Debt
Accounts receivable that cannot be collected and must be written off as an expense.
Bad debt occurs when a customer who owes money is unable or unwilling to pay and the amount is deemed uncollectible. Two methods exist: the direct write-off method (recording when a specific account is uncollectible) and the allowance method (estimating in advance based on historical patterns). GAAP generally requires the allowance method.
Example
A web hosting company has a $3,200 invoice outstanding for 180 days—after the client declares bankruptcy, it writes off $3,200 as bad debt expense.
Why It Matters for Your Business
Bad debt directly reduces your profit, and tracking patterns helps you tighten credit policies and screen clients more carefully.
Practical Tips
- •Set up an allowance for doubtful accounts based on your historical collection rates.
- •Run credit checks on new clients before extending payment terms.
- •Escalate collection efforts at 60 days overdue—the longer you wait, the less likely you'll collect.
Related Terms
More Accounting Terms
Accounts Payable
Money owed by a business to its suppliers or creditors for goods or services received but not yet paid for.
Accounts Receivable
Money owed to a business by its customers for goods or services delivered but not yet paid for.
Accrual Accounting
An accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged.
Asset
Any resource owned by a business that has economic value and can provide future benefits.
Balance Sheet
A financial statement showing assets, liabilities, and equity at a specific point in time.
Related Financial Guides & Resources
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