What is Bad Debt? 

Bad debts are not good for a business. Sometimes, you may have followed all the steps to prevent cash flow problems and late payment, but you can still be impacted by non-payment. When a customer defaults on its bills or is in danger of doing so, the company extending credit to that customer faces a bad debt expense. The bad debt expense must be charged against your company’s accounts receivable and consequently reduces the amount of accounts receivable on your company’s income statement.

Bad debt expense can be detrimental to a business’s long-term success, but fortunately there are ways to manage this expense and mitigate bad debt-related trade risks. In this article, we share information on bad debt protection cost, bad debt protection insurance, and bad debt protection vs credit insurance.

While one or two bad debts of small amounts may not make much of an impact, large debts or several unpaid accounts may lead to significant loss and even increase a company’s risk of bankruptcy. Bad debts also make your company’s accounting processes more complicated and, in addition to monetary losses, take up valuable staff time and resources as they unsuccessfully try to collect overdue payments and unpaid invoices. In these cases, the bad debt protection cost is very much justified.

Bad debt protection can help limit some losses when customers are unable to pay their bills. While a company is unlikely to avoid bad debt expense entirely, it can protect itself from bad debt in a number of ways such as allowance for bad debts.

Another way is for companies to set various limits when extending customer credit to minimise bad debt expense. Such limits can be set to manage existing and potential bad debt expense overall and for specific customers. For example, a company could dictate tighter credit terms based on each customer’s unique circumstances. In some cases, a company might avoid extending credit at all by requiring its client to procure a letter of credit to guarantee payment or require prepayment before shipment.

In some cases, companies may also want to change the requirements for extending credit to customers. For example, if customers in a certain industry or georaphic area are struggling, companies can require these customers to meet stricter requirements before the company will extend credit. The same strategy could be used to manage credit for customers that have outstanding debts over a certain amount or that are a certain number of days late on their bills.

The bad debt protection cost for your business and specific needs depends upon the type of protection you buy.

It usually varies depending on the provider, the nature of your business, your business industry, the level of finance and the timeframes. So the first thing you should do is ask for a bad debt protection insurance quote.

Bad debt protection insurance provides payment when a customer is insolvent and is unable to pay its bills. Any losses are absorbed by the finance provider rather than your own company.

It is particularly useful in the case where you have a doubt about some specific clients’ ability to pay in due time. This way, it ensures you have a safety net, especially if these clients have had past experiences of bad debt or if they represent a large percentage of your total revenue.

Bad debt protection insurance also saves you staff time and resources you would have spent on accounting processes and on the collection on the debts.

However, because there are reasons other than insolvency for customer non-payment, this type of bad debt account protection is of limited use for most companies.