Effects of Bad Debt on Accounting
26

Aug 2020

Accounting is an integral part of a company and is regarded as the lifeblood of a company. Without accounting, it will be very challenging for a company to understand the inflows and outflows of cash in the company. One of the crucial things to comprehend in Accounting is Bad Debt and its effect on the accounting books of the company.

Bad debts can be very bad for a business, and every business tries to stay away from such debts, but at some point in time, each business has to deal with bad debts. If the company has a lot of prior debts which has gone bad or is not recoverable, then in certain cases, the company might have to liquidate.

Let us understand what does one mean by Bad Debt and what are its effects on the accounting books of the company.

What is Bad Debt?

Bad Debt can be regarded as an accounting expense that is not collectible either due to any circumstances created between the debtor and the creditor. There may also be cases that the money is owed to the creditor, but no action is taken on behalf to collect the money. In short bad debt is the money which has not been and cannot be recovered by the creditor.

Bad Debts can be defined as per the choice of the accounting method used by the entity, the regulatory treatment done, accounting provision being used in the treatment, etc.

How can Bad Debt Affect Accounting?

Having Bad Debts in your accounting books can affect the business in many ways, such as:

1.A Rise in the Debtor Count

Every business must provide the proper amount of debts. By this, we mean to say that a company must first understand the requirements of the business and how much cash is required for the basic functioning of the business. If the proper amount of debts provided or taken up is not maintained, then the company will not be able to function properly. A higher number of bad debts will mean that the management is not able to take care of the business, and in time the company will have to close. 

2.Affects the Budget of the Company

Creating a budget of a company helps the management to understand which function of the company requires more funds and which function is already adequate in comparison. If the company has a higher debt count, then the management will have to focus on removing the Bad Debts first. This will complicate the situation as the functions which require funds will not be attended at first, which will, in turn, decrease the efficiency and profitability of the company.   

3.Liquid Cash not available when needed

Liquidity in a company is of paramount importance. IF the management has liquid cash in hand, the company can attain more resources, machinery, etc. at a quicker pace, but if there are many bad debts, then the company will not be able to correctly use the solution to the problem. with liquidity in hand, a company may be able to think of expanding the business at a moment’s notice.

4.Affects the Goodwill of the Company

When the various Auditing and Accounting reports are prepared, they are made available to both the management and the investors. They can even be available to the potential investors of the business. The potential investors will invest in a company only if the goodwill of the company is good. If a company has many bad debts, it raises a question on the management style, and it might be likely that in the future, the company will not be able to sustain itself. Thus understanding bad debt is very important, which affects the goodwill of the business.

  1. Can Decrease Investor Confidence

If a company have a large number of bad debts, the first thought which will come into the investors' mind is that the management of the company is very gullible and no matter how much profitable the company is, in the long run, the company will have to shut down due to its bad management strategies. This means that fewer investors will come to the company to invest.

These are some of the reasons due to which Bad Debt can spell trouble for the accounting of a company. This is also why the management should take the assistance of third-party consultancies, which will help manage the company in a better way.

If you are searching for such consultancy in the United Arab Emirates, then you must have a look at the services provided by JAXA Chartered Accountants. The dedicated experts in JAXA will not only help find the solution for the problem being faced by the company but will also assist in the better management of the company. They also provide services relating to Auditing, Accounting, Payroll, VAT and Taxes, and many more. For more details on the services provide you can Contact Us, we will be happy to provide answers for all your queries.