Bad Debt

What Is Bad Debt?

Bad debt occurs when a customer who owes you money cannot or will not pay. This might happen because the customer went bankrupt, disputes the charge, has disappeared, or simply refuses to pay despite repeated collection attempts. Once you determine that collection is unlikely, the debt is classified as bad debt and written off.

For example, a plumbing company completes a $3,000 job for a customer who then goes out of business without paying. After multiple collection attempts over several months, the plumber determines the debt is uncollectable and writes it off as bad debt expense.

Why It Matters for Your Business

Bad debt directly reduces your profitability and can signal problems with your credit policies or customer selection.

• Profit impact: Every dollar of bad debt comes directly off your bottom line. If your profit margin is 10%, a $1,000 bad debt requires $10,000 in new sales to replace the lost profit.
• Cash flow drain: You already spent time, resources, and money delivering the product or service. Bad debt means you did that work for free.
• Tax deduction: The silver lining is that bad debt can be written off as a business expense, reducing your taxable income. Proper documentation is essential for claiming this deduction.

Preventing bad debt starts with credit checks on new customers, requiring deposits for large orders, setting reasonable payment terms, and acting quickly when invoices become overdue. A small investment in prevention saves significant losses from bad debt.