What is Bad Debt Expense?
The Short Answer
Bad Debt Expense explained simply
Bad debt expense is the money a business loses from customers who can’t or won’t pay their bills. It is an accounting term for receivables that are unlikely to be collected. Businesses account for this loss to accurately reflect their financial health. This expense reduces a company’s accounts receivable and its net income. It’s a normal part of doing business, especially for companies that offer credit to customers.
Real-World Example
The Unpaid Invoice
Imagine a small consulting firm, "Venturu Consulting," completes a project for a client, billing them $5,000. The client promises to pay in 30 days. After 90 days, despite multiple reminders, the client still hasn’t paid and has gone out of business. Venturu Consulting determines this $5,000 is now uncollectible. They record this as a bad debt expense. This means their accounts receivable decreases by $5,000, and their profit for the period is also reduced by $5,000.
Why this matters
Bad debt expense matters because it directly impacts a business’s profitability and cash flow. High bad debt can signal issues with credit policies or customer quality. For buyers, understanding a seller’s bad debt expense helps them assess the true value of accounts receivable and the overall financial health of the business.
Always review a business’s bad debt history. It tells you a lot about their customer base and how well they manage credit. High bad debt can hide deeper problems.
Always review a business’s bad debt history. It tells you a lot about their customer base and how well they manage credit. High bad debt can hide deeper problems.
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