What Are the Effects of Bad Debt on a Company?

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There are many different types of financial harm that can affect a business, but a bad debt write-off can be one of the most difficult to recover from. In simple terms, a bad debt is any money owed to your organisation that you do not expect to receive back. Needless to say, for a company that has made financial plans based on the assumption that the debts they are owed will be paid, writing off a bad debt can be devastating.

There are many different ways to approach debt management, and in some cases, businesses can mitigate the damage of bad debts by managing their finances carefully. Here, the experts at Company Insolvency Advice will explain how organisations can plan around bad debts, outline the potential consequences of bad debt write-offs, and discuss what you can do if you are concerned about the financial position of your company following this type of incident.

If your business is facing financial difficulties and you are concerned about your ability to pay the company’s debts, it is important to act quickly to resolve these challenges. You can be proactive in avoiding bad debt, but if it is already too late, there may still be solutions you can pursue. Contact our experts to discuss the company rescue strategies that may be able to restore your business to good financial health, and start the process of recovering your company.

What are bad debts?

To an inexperienced person, it may seem that all debts are bad, but in fact, this is not the case. There are many types of debt that businesses will encounter on a regular basis, from large-scale financial obligations like business loans to smaller-scale debts like services offered on credit. In business terms, debts are considered in terms of their value, which means that they are not automatically negative. However, debt management should be a key part of every business’ financial planning and cash flow strategy to avoid the specific challenges of bad debts.

The term ‘bad debts’ refers to any amounts of money owed to a business that are unlikely to be paid back. This can happen for a variety of reasons – customers may fall into insolvency or get into a dispute over the product or service delivered. In some cases, a business incurs bad debts when they fall victim to fraud. Whatever the cause, it is important to consider the ways you can approach bad debt in order to mitigate any negative impact on your organisation.

Bad debts are typically recognised as an expense in the company’s income statement, which reduces the net income of the business. In the most serious circumstances, they can cause serious cash flow problems for your company as a creditor, and needing to write off a bad debt expense can affect the solvency of the business.

In some cases, these bad debts can be avoided, managed or anticipated, which can help you to minimise the impact on your business. We will explain this alongside the potential consequences of bad debts for organisations below.

What are the potential effects of bad debt?

Bad debts can have several implications for businesses, and it is important to consider how you may be affected before you decide to offer a customer a line of credit. Your credit control policies and payment terms are directly tied to the risk of bad debts destabilising your business, so if you are in this position (or concerned that it may arise) you should review these first.

The most immediate effect of bad debts is the direct impact on the company’s financial health. When a business cannot recover the money it is owed, it reduces the revenue and, subsequently, the profitability of the business. This can limit the company’s ability to reinvest in its operations or return profits to shareholders.

As well as the top-level financial health of the business, bad debts can lead to cash flow problems, especially for small and medium-sized enterprises (SMEs) that operate on thin margins. Businesses may struggle to pay their suppliers, meet payroll obligations, or invest in growth opportunities. In severe cases, cash flow issues can worsen and affect the future viability of the business.

If you decide to try to pursue the money you are owed through legal action or by chasing payment, this can also create extra expenses in terms of money and time – especially if you pay for debt collection services that ultimately prove unsuccessful. 

If a company consistently has high levels of bad debts, it may indicate poor credit management. This can affect the company’s credit rating, making it more expensive, or even impossible, to borrow money in the future. Strong credit control policies can prevent bad debts from affecting your business in this way – as a minimum, you should carry out credit checks on customers before offering them credit and set reasonable payment terms, which can allow you to act more quickly in response to unpaid debts.

How can businesses avoid the challenges of bad debt?

There are several approaches businesses can take to managing bad debt, the first of which is to prevent it. As we have said, the best way to prevent bad debt is careful credit control. This means not only that you have procedures in place to determine how and when to provide credit, and identify an unsuitable customer before you offer them credit, but that you have a strategy for collecting late payments.

If a customer fails to pay on time, they should understand what the consequences will be, as this can help to ensure that finances are managed effectively. Speak to the experts at Company Insolvency Advice for insights into how you can implement effective credit control procedures and begin to manage your finances more effectively so that you can avoid the dire consequences that might otherwise arise.

Thankfully, when bad debt does arise, UK businesses can benefit from a tax relief that may help to mitigate their losses. If a debt is identified as ‘bad’, meaning that it can’t be recovered, then that amount is deducted from the business’s taxable profit. However, the rules around this can be complex, so businesses must carefully assess when and how much tax relief they can claim, or speak to an advisor for guidance.

If your company is an SME and operates on relatively small margins, the final thing you should consider is trade credit insurance, also called bad debt insurance. If you are working with a financial services company – for example, if you are pursuing invoice factoring or invoice discounting to recover your debts – they will usually offer this as an add-on, and this can ensure that you still receive the money your company expects even if your customer does not pay.

What should my business do?

The most important thing you can do is to be proactive in avoiding bad debt. To mitigate the risk of bad debts, companies should perform credit checks on new customers, have a clear credit control process, and consider taking out credit insurance. It is also crucial to recognise potential bad debts as early as possible and make adequate provisions in the financial statements.

If you have failed to do so, it may not be too late. If you are facing challenges with cash flow due to bad debts or are concerned that your business will be unable to pay its own debts, the good news is that there are often strategies you can use to maintain good financial standing for your company. This might mean changing your approach to managing cash flow, securing a payment plan with your own creditors, or another approach. 

Contact the team at Company Insolvency Advice today to learn how you can restore your business to financial solvency and explore the options available to you. Call us today on 0800 999 0666 or use our online enquiry form to request a call back at your convenience.

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Business Advice Expert

Robert Cooksey

Robert Cooksey

Director Advice Line: 0800 999 0666


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Company Insolvency Advice is a leading business rescue, corporate restructuring and insolvency specialists, with years of experience in providing corporate debt solutions. We understand the daily pressure you are under as a director and our team of expert consultants cover the whole of the country in order to discuss debt solutions with company directors.

The first port of call should be to consult with a licensed insolvency practitioner to discuss your options. Thankfully, you can arrange a free initial consultation with one of our local insolvency practitioners at your convenience.

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