Every small business owner wants to know the answer to this question: “Can I write off bad debt”? The answer is mostly yes, especially when your a business who has receivables. Learn what is means to write off bad debt and why you should prevent it at all costs.
Write Off Bad Debt: What It Means and Why You Should Prevent It
When operating on credit, you are considered to have earned your revenue when you have delivered your service or goods. Immediately following, as you are not expecting cash-on-delivery, your receivables should be carried on your books until you get paid (or give up on getting paid).
When you list receivables on your books, they are current assets, as you are assuming they will be cash within the year. However, when operating on credit with a customer, you are considered an unsecured creditor. This means you are not protected if the debtor declares bankruptcy (unless your services come under a lien statute in your state). Therefore, write-offs are to be expected when you have receivables.
When writing off your unpaid receivables, always take the less optimistic view. Use a more conservative estimate on the number of your receivables that won’t be paid. It’s not about being exact; you don’t need to guess who won’t pay you or the exact amount that won’t be paid but you do need to report an estimate of how much you don’t think you’ll collect. The IRS requires the direct write-off method for receivables. You can only write off bad debt when you actually give up on collecting it. How do you decide when it’s time to give up? Look at how long the account has been past due. If an account is 90 days past due, it’s near impossible to collect so anything older than that is safe to assume is a lost cause.
When you write off bad debt, you are essentially waving the white flag. However, you are also denying yourself the money you are rightfully owed. Write-offs can have a huge effect on your business. What do we mean?
For example, if you had $25,000 is write-offs last year and a profit margin of 5%, you would need $500,000 in additional sales to compensate for that.
You can use our write-offs monitor to calculate how many additional sales YOU would need to make to compensate for your write-offs.
It really is that extreme. Needless to say, if you can avoid having to write off bad debt, you should. And there should really be no “if”, because you can. By staying on top of late invoices and learning how to take control of your receivables management, you can keep yourself from ever having to write off bad debt.