Our vision is to revolutionize and automate the loan servicing workflow of the global financial community.

A Guide to Calculating and Tracking Bad Debt Expense

guide bad debt

Bad debt expense is an inevitable part of doing business, especially for companies that extend credit to their customers. Effectively managing bad debt is crucial for maintaining financial health and ensuring long-term success. In this guide, we'll talk about calculating and tracking bad debt expenses and actionable insights for businesses of all sizes.

Understanding Bad Debt Expense

Bad debt expense refers to the amount of money a company expects to lose from customers who default on their credit obligations. While businesses strive to minimize bad debt, it's nearly impossible to eliminate it. Therefore, it's essential to accurately estimate and account for bad debt expenses to maintain accurate financial records and make informed business decisions.

How To Calculate and Track Bad Debt Expense

Calculation Methods

Several methods exist for calculating bad debt expenses, each suited to different business contexts. Two common approaches are the allowance method and the direct write-off method.

Allowance Method

Under the allowance method, businesses estimate bad debt expenses based on historical data and current economic conditions.

The process involves creating an allowance for doubtful accounts, which represents the portion of accounts receivable expected to be uncollectible.

To calculate the allowance, businesses may use statistical techniques, aging schedules, or a percentage of sales approach.

Adjustments to the allowance are made periodically to reflect changes in the economic environment or customer payment behavior.

Direct Write-Off Method

The direct write-off method involves recognizing bad debt expenses only when a specific customer's account is deemed uncollectible.

While simpler than the allowance method, the direct write-off approach is less accurate since it only considers potential bad debts once they occur.

This method is typically used by smaller businesses or those with fewer credit transactions.

Tracking Bad Debt Expense

Once bad debt expense is calculated, businesses must track it effectively to monitor trends, identify potential issues, and make strategic adjustments. Here are some key steps for tracking bad debt expenses:

  • Maintain Detailed Records: Keep thorough records of all credit transactions, including customer information, payment history, and collections efforts.
  • Regular Reconciliation: Reconcile accounts receivable and allowance for doubtful accounts regularly to ensure accuracy in financial reporting.
  • Analyze Trends: Monitor trends in bad debt expense over time, comparing actual results to initial estimates. Identify any significant deviations and investigate underlying causes.
  • Customer Segmentation: Segment customers based on credit risk to tailor collection strategies and credit terms accordingly. High-risk customers may require stricter credit policies or more frequent monitoring.
  • Continuous Improvement: Continuously review and refine credit policies and collection procedures to minimize bad debt risk and improve overall financial performance.

  • Calculating and tracking bad debt expenses is a vital aspect of financial management for businesses that extend credit to customers. Companies can minimize financial losses, improve cash flow, and sustain long-term growth by implementing effective methods for estimating bad debt and maintaining rigorous tracking processes.

    If you'd like to learn more about our loan servicing software or how we can help you, email us at