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You As a Business Owner Should Be Aware Of Your Bad Debt Expense

A business will invariably have to practice a policy of credit to attract customers and enhance sales. However, it is the sad experience of many companies that some of these debts become ultimately irrecoverable and an expense to the business, termed "bad debts". As such, it would be prudent to estimate beforehand the debts that may prove to be finally irrecoverable as a percentage of the total due from your customers.

Debts become bad due to a variety of reasons such as insolvency or lack of cash with the company to which you have sold on credit, which in turn may be a cause of your debtor company's business doing badly. If your customer happens to be a sole proprietorship or a private individual, then his personal ill health or a member of his family, unemployment, bankruptcy, loss of assets due to fire or other causes not adequately covered with insurance may contribute to his inability to honor your debts.

Bad debts is an expense recognized by standard accounting practices, and many companies make provision for such an eventuality as a percentage of the total debt or on an individual customer basis where there are known reasons to justify such a possibility. However, adhering to a policy of granting credit judiciously and in a more controllable manner instead of on a purely "blind" blanket basis is a possible means of avoiding or minimizing bad debts.

In granting credit, you can grade your customers according to their known or expected patterns of purchases and payments in determining different credit limits as well as different credit periods for different customers. There are rating agencies that maintain and supply "credit scores" of trading companies from their databases based on their creditworthiness. Additionally you can ask the customer himself to furnish referees of standing who can speak or guarantee for his creditworthiness You can further press on payments in default by refusing any further supplies until they bring their total indebtedness within the stipulated limits and settle all debts already past due irrespective of them falling within the stipulated limit or not. If not for these controls, your sales department may happily go on increasing sales by giving too much on non-recoverable credit, leaving the entire headache of collecting payments and managing cash flow solely on the accounts department.

Another good hedge against incurring heavy bad debts is to take an insurance cover against possible and estimated bad debts with a company that provides such services known as "factoring services" so that the onus of collecting the debts fall on the factoring company for an agreed fee.

The fear of incurring bad debts should not keep you from maximizing your sales by supplying only to those customers with a 100% probability of collection. By adopting a good credit control system, you can achieve the dual targets of enhancing sales and maximizing profitability by ensuring the efficient and speedy collection of debts

Your credit control system should not be one that will scare away good customers too from approaching you. Hence, the need to grade your customers based on various data available to you and any previous experience. The accent should be on distinguishing between good, doubtful and bad customers and extending credit to them accordingly whereas if you practice a uniform policy for all, you will be alienating a lot of good customers if your policy is too harsh while piling up bad debts if it is too liberal.

Identifying a really bad debt is important from what may be partially recoverable or through granting extended time for settlement. While clearly defining how borrowers (customers) may be graded, it is also important to clearly define the authority for write offs and at what stage (after trying different avenues available for collection) a debt may be finally removed from the books of accounts as a bad debt.

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