What is bad debt?
Bad debt refers to an irrecoverable receivable: a type of expense that occurs when a customer to whom you have extended credit is no longer able or willing to pay you.
Bad debts are not good for a business. Sometimes, you may have followed all the steps to prevent cash flow problems and late payment, but you can still be impacted by non-payment. When a customer defaults on its bills or is in danger of doing so, the company extending credit to that customer faces a bad debt expense. The bad debt expense must be charged against your company’s accounts receivable and consequently reduces the amount of accounts receivable on your company’s income statement.
Bad debt expense can be detrimental to a business’s long-term success, but fortunately there are ways to manage this expense and mitigate bad debt-related trade risks. In this article, we share information on bad debt protection cost, bad debt protection insurance, and bad debt protection vs credit insurance.
What is bad debt protection?
While one or two bad debts of small amounts may not make much of an impact, large debts or several unpaid accounts may lead to significant loss and even increase a company’s risk of bankruptcy. Bad debts also make your company’s accounting processes more complicated and, in addition to monetary losses, take up valuable staff time and resources as they unsuccessfully try to collect overdue payments and unpaid invoices. In these cases, the bad debt protection cost is very much justified.
Bad debt protection can help limit some losses when customers are unable to pay their bills. While a company is unlikely to avoid bad debt expense entirely, it can protect itself from bad debt in a number of ways such as allowance for bad debts.
Another way is for companies to set various limits when extending customer credit to minimise bad debt expense. Such limits can be set to manage existing and potential bad debt expense overall and for specific customers. For example, a company could dictate tighter credit terms based on each customer’s unique circumstances. In some cases, a company might avoid extending credit at all by requiring its client to procure a letter of credit to guarantee payment or require prepayment before shipment.
In some cases, companies may also want to change the requirements for extending credit to customers. For example, if customers in a certain industry or georaphic area are struggling, companies can require these customers to meet stricter requirements before the company will extend credit. The same strategy could be used to manage credit for customers that have outstanding debts over a certain amount or that are a certain number of days late on their bills.
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