What is bad debt?

Bad debt is money a customer owes your business that you no longer expect to collect. It usually starts as a normal unpaid invoice in your accounts receivable and is later written off as uncollectible.

How it works

Not every late invoice is bad debt. A client who pays 20 days late still pays. Bad debt is the portion you decide will never arrive, for reasons such as:

• The customer went out of business or filed for bankruptcy.
• You cannot locate the customer.
• The customer disputes the work and refuses to pay, and collecting is not worth the cost.
• The invoice is so old that collection efforts have failed.

When you decide an invoice is uncollectible, you record it as a bad debt expense and remove it from receivables. This is called a write-off. Businesses that use accrual accounting often estimate bad debt in advance, based on past experience, and set aside an allowance. How you record it depends on your accounting method, so check with an accountant.

The older an invoice gets, the lower the chance of collecting it. An aging report helps you see which invoices are drifting toward that point.

Example

A cleaning company has $38,000.00 in invoices over a year.

How to reduce bad debt

1. Check new clients. A quick look at their business, references or payment history helps for larger jobs.
2. Take deposits. A deposit invoice reduces how much you are exposed to.
3. Use clear terms. State the due date and late fee on every invoice. The due date calculator can help you set the date.
4. Invoice quickly. The sooner you ask, the more likely you are to be paid.
5. Follow up consistently. A set reminder schedule, known as dunning, catches problems early.
6. Act early on trouble. Pause work for clients with large overdue balances.

PayToMe is in public beta, and you can sign in to PayToMe to send invoices and take online payments. Smart reminders and a cash-flow forecast, which would help with this, are in development.

Related terms

• Write-off: removing an uncollectible invoice from your books.
• Accounts receivable: money customers owe you.
• Aging report: shows which invoices are overdue.
• Deposit invoice: collecting part of the payment up front.