The Potential Impact of Bad Debt on Your Construction Business
Understanding bad debt and the impact of business write-offs.
Large levels of bad debt can be difficult for construction companies to handle, which may make it impossible to continue operating. Businesses must do all they can to avoid collection-related bad debt. Here's a quick breakdown of types of bad debt and what business owners can do to reduce their exposure to this type of financial loss. We will discuss how to write off bad debt in QuickBooks Online, Xero, Sage Intacct and how to reverse the process.
But first we need to understand what is a bad debt.
Bad debts occur when you can't collect money owed to you from a borrower. This results in credit losses, or having to write the debt off by writing it down on your books of account and affecting your net earnings.
Bad debts are most often incurred when an unsuitable customer is given credit, for example extending payment terms too far into the future. One of the worst consequences of bad debt is that a company’s cash flow is disrupted, which in turn leads to lowered profitability.
Furthermore, investment plans can be delayed because of low-profitability (which stems from bad debt). The absolute worst-case scenario for any company experiencing bad debt is insolvency.
How to avoid bad debt.
Obviously, no one can predict the future, but there are many steps that can be taken by businesses to avoid bad debt in the first place.
Do your due diligence
Receiving your prospective customers’ credit information is essential to reducing your business’s risk of bad debt. Ultimately, the results of a credit check will let you decide whether or not you should work with another business, customer, or partner.
Implement effective credit control
A good credit control strategy will drastically reduce your risk of bad debt, proactively track and collect payments after they are due, suggest alternatives (if necessary), and ensure your credit control team has expertise in dispute resolution techniques.
Protective measures against bad debt
Businesses who wish to protect themselves from the dangers of bad debt should seek out a bad debt protection service.
Writing off bad debt in QBO, Xero, Sage, and Intacct
In your online accounting software, writing off bad debt will be a similar process no matter what program you’re using.
Once it is clear a business or client cannot/will not pay, after checking your accounts receivable, you will simply create a bad debt account under your “expenses”. You will then create a new expense item and the expense will be removed from AR and instead itemized in bad debts.
You’ll want to create a credit memo on the customer’s account and will indicate that it is a write off in the “income amount” section of the client account. You’ll also apply the bad debt credit memo to the associated payment/invoice record for that client. The uncollectible receivable is now listed in the Bad Debts expense account in your Profit and Loss report.
How to reverse bad debt write-offs
When you receive the payment on a bad debt you wrote off (yay!), you must reverse the bad debt write-off entry. Increase the account receivable account with a debit and decrease the bad debt expense account with a credit to reverse the write-off entry, if the payment is received within the same tax year. Record the payment transaction as a debit on cash and as a credit on receivable accounts.
For example, if a client pays you 75 days after you wrote off their invoice, you would reverse the journal entry and indicate:
Accounts Receivable - Debit $100
Bad Debts Expense - Credit $100
Record the payment like this:
Cash - Debit $100
Accounts Receivable - Credit $100
It's never a pleasant experience to have bad debt, but it's better to reverse these debts than write them off.. It’s a little tricky when it comes to the accounting side of things, but that is why we have partnered with Dryrun, which is an advanced software capable of forecasting potential bad debt and its impact on your cash flow.
If you are interested in finding the best services to ensure that your bad debt risk is kept to a minimum, contact our team at Spectral Accounting today to find out how our cash management services can support your business.