Allowance for Doubtful Accounts: Calculate & Manage Bad Debt

As you get ready to launch a new business or take yours to the next level, knowing how to use debt correctly can make the difference between success and failure. Bad debt is an expense that a business incurs once the repayment of credit previously extended to a customer is estimated to be uncollectible. A write-off refers to a business accounting expense reported to account for unreceived payments or losses on assets. The same principal amount is more expensive to pay off at a 10% interest rate than it is at 5%.

• Since the interest on a debt must be paid regardless of business profitability, too much debt may compromise the entire operation if cash flow dries up.
• Therefore, it is crucial to evaluate debt-to-equity ratios relative to industry peers or the same company at different stages of its development.
• In this article we’ll explain what a debt-to-equity ratio is, how to calculate one, and what it can tell investors about your business.
• Fixing inefficiencies could go a long way toward helping with your business funding, even without taking on a loan.
• Over the same period, auto loans totalled 2.39 trillion baht, contracting by 0.8% month-on-month and 8.8% year-on-year.

Financial

It’s critical to learn the difference between good debt and bad debt in order to make sure you are using debt the best way for your business. However, this figure has been trending downward; compared to 2022 levels, the ratio decreased by 0.4 percentage points in 2023. A similar trend emerged in the debt-to-accounts receivable ratio—it decreased from 38.13% to 37%, a drop of 1.13 percentage points from 2022 to 2023. Over this three-year period, companies witnessed a Compound Annual Growth Rate (CAGR) of 7.49% in sales revenue, indicating healthy top-line growth. Accounts receivable grew at a slightly lower rate of 6.94%, which is generally positive as it suggests effective collection management relative to sales growth.

If you have too much debt at a high-interest rate, the payments you have to make each month could hurt your company’s cash flow. This could limit your ability to pay other bills or make the required investments to grow your business and make it successful. If business slows down, as it has for many companies during the coronavirus pandemic, then it can be difficult to pay that debt month after month. From a pure risk perspective, lower ratios (0.4 or lower) are considered better debt ratios. Since the interest on a debt must be paid regardless of business profitability, too much debt may compromise the entire operation if cash flow dries up.

If your answer to those questions is ‘yes’ across the board, then the next step is to make sure you don’t take on too much debt. Good debt does not include spending money you don’t have on big ticket items for the sake of looking flashy. Without a good reason for going into debt, the debt quickly shifts from ‘good’ to ‘bad’. From a business perspective, of course, the reason you make an investment should be to bring value to yourself. The amount of debt that your business will be comfortable handling might be way too much for another company to take on, and vice versa.

It requires a tailored approach that considers the unique aspects of each business, leveraging a combination of foresight, innovation, and stringent policy enforcement to maintain financial health. A high bad debt ratio can impede cash flow, as funds that were expected to be available for operations remain uncollected. For example, a company projecting \$100,000 in cash flow but facing a 15% bad debt ratio effectively has only \$85,000, impacting its ability to reinvest or pay obligations. A company can improve its debt ratio by cutting costs, increasing revenues, refinancing its debt at lower interest rates, improving cash flows, increasing equity financing, and restructuring. You can enter details for an actual loan offer you received or play around with the sliders to see how different interest rates and repayment terms impact savings. A debt ratio is calculated by dividing the total liabilities by the total assets.

High Performers’ Bad Debt Mitigation Strategies

As businesses face higher interest rates and tightening credit conditions, bad debt is poised to become an even bigger challenge. But with the right credit management and collection strategies, companies can minimize its impact. The average ratio in 2023 was 1.49%, exceeding both high and low performer thresholds. This indicates that while some companies manage bad debt effectively, many grapple with higher ratios, potentially impacting their financial health and operations. When assessing the financial health of a company or an individual, one crucial financial metric to consider is the debt ratio. The debt ratio, also known as the debt-to-assets ratio, provides valuable insights into the proportion of debt a business has in relation to its total assets.

Using the Percentage of Sales Method

Automobile loans are somewhere in the gray area between types of good debt and types of bad debt. Business loans are often difficult to obtain from traditional lenders like banks. That’s why Become works with businesses that are striving to reach their goals and helps guide them toward improving their funding odds and secure funding through alternative means.

The companies with the best ratio (best performers) reported a value of 0.02% or lower. For example, if you use your personal computer for work, that debt is considered consumer debt. Meanwhile, if you have business credit card debt from a company expense card, it is considered business debt. We have financial relationships with some companies we cover, earning commissions when readers purchase from our partners or share information about their needs.

Debt may seem counterintuitive to keeping a positive cash flow, but, if handled wisely, debt actually can be the key to sustaining a strong cash flow. Equity financing is best for startups in industries such as high-tech, where the return on investment is projected to be astronomical. And that makes sense, being that angel investors and venture capitalists aim to gain a percentage of ownership of a company that will flourish. On the other hand, if for no other reason, you may need a car in order to travel to and from work. That in-and-of-itself contributes value and provides you with the ability to earn an income (even more so if your business depends on making deliveries and/or attending meetings in person). Beyond that, the relatively low interest rates (under 5% APR in many cases) that most auto loans offer make them that much more enticing.

• Some of the companies also mention using AR factoring to achieve their cash flow targets and minimize write-offs.
• For example, if a company had $100,000 in bad debt and $1,000,000 in total sales, the bad debt-to-sales ratio would be 10%.
• A higher ratio may be a sign that a company is using too much debt to finance its operations.
• The key to fortifying against this threat lies in the implementation of robust strategies that not only identify potential risks but also mitigate them effectively.
• There are many reasons business owners should consider taking on debt to finance their company.

Using debt ratios to establish a healthy level of debt

Bad debt owed to your business is debt that technically cannot be recovered, such as your customer becoming insolvent. With UK Government Covid-19 support schemes wrapped up, the BoE’s Financial Policy Committee (FPC) has predicted that business insolvencies are expected to increase from historically low levels. Learn about some of the advantages and disadvantages of using an international bank account for your business with our guide. Learn how a Community Development Finance Institution can help your business get a loan, even if you’ve been rejected for finance previously.

What is a Healthy Amount of Business Debt?

Choose your business’s average monthly revenue over the last three months from the available options. When we started, you may have been wondering “why is debt good for a company”. Chances are, if someone takes a loan for $500, they may face some difficulties paying back the loan with an additional $75 in interest. Payday loans frequently snowball, and before you know it you may be hundreds of dollars in debt as a result of trying to fix your finances with a payday loan.

By examining these dimensions, businesses can develop a nuanced understanding of their financial standing. For example, a small tech startup realizing what is a bad debt ratio for a business a bad debt ratio of 5% might initially seem alarming. In assessing the financial health of a company, particular attention must be paid to the efficiency with which it recovers outstanding debts. This metric not only reflects on the company’s current liquidity but also serves as a predictor of future cash flows and profitability.

Credit card loans were 571 billion baht, decreasing by 1.7% month-on-month and 0.8% from a year earlier. According to NCB data, as of January 2025 NPL Account 21 comprised 2.2 million borrowers, accounting for 2.9 million loan accounts with a total outstanding balance of 201 billion baht. It’s also worth taking a closer look at your financial processes to see if there’s room for improvement.

The bad debt to sales ratio is calculated by dividing the amount of bad debt by the total sales for a period of time. For example, if a company had $100,000 in bad debt and $1,000,000 in total sales, the bad debt-to-sales ratio would be 10%. For starters, there are big tax incentives for using debt versus equity within a company. Depending upon the interest rate and the expected rate of return on an asset or other investment the company plans to make, debt can be a relatively inexpensive source of capital, too. However, it’s important to be aware of general debt ratios when analyzing money owed and forecasting your company’s finances. For instance, investors or other businesses interested in acquiring or merging with your company will want to see a debt ratio between 30 percent and 60 percent.

The same way that payday loans can snowball out of control, leaving credit card debt unchecked will lead you towards a situation that will be very difficult to escape from. Among the 67% of Americans who have credit cards, the average amount owed is more than $6,000. This is concerning, but not as concerning as the interest rates offered by some credit card companies that can exceed 40% annually. This results in the average household paying more than $1,000 in interest on their credit cards every year. Arriving at a debt ratio is not an exact science, however, and many variables affect the outcome and how it might be viewed by stakeholders and investors. These factors can include the nature of the business itself, the industry in which it operates, and its previous trading history.

It represents the portion of accounts receivable that a company expects will never be collected. Businesses should regularly analyze their historical bad debt trends and compare them to industry standards to determine an appropriate allowance percentage. Perhaps the most notorious of all types of bad debt, credit card debt is definitely not something you want on your shoulders. Offering personal and business banking services, including checking, savings, mortgages, business loans and more.

How Can a Company Improve Its Debt Ratio?

However, the line between leveraging debt for success and falling into financial turmoil can be thin. Understanding how to effectively manage debt is crucial for the long-term sustainability and prosperity of any business. Unexpected costs can drive it and bad debt can come in the form of short-term, high-interest loans to cover cash shortfalls, for example. A healthy level of debt supports business growth and helps smaller businesses expand their market share. The economic impact of Covid-19, soaring inflation and interest rates, along with cash flow challenges linked to supply chain constraints have led to a surge in smaller business borrowing.