Handling bad debt in your business plan Follow

Bad Debt is a term used to describe outstanding Accounts Receivable which the business has been unable to collect. As such, the business is prepared to write these amounts off as "bad debt," a cost of sales. But should the amount of bad debt then be deducted from the balance of Accounts Receivable to properly "balance out"? And if it's removed from the balance of Accounts Receivable wouldn't that, in turn, increase Cash from Receivables and throw off the Cash Flow?

Resolution

In Business Plan Pro, first make sure that you are set for Sales on Credit in your Table Settings, at the correct percentage and collection days (60 days is usually the minimum realistic collection for plans with business to business sales). Then, think about how long you will try to collect these debts past your usual collection days before writing them off as bad debt. An extra 60 days? 90 days? This probably depends on how big the debt is, relative to your current cash flow. Once you've figured that out, you could put the estimated amount of future bad debt in the Profit and Loss table, either as a direct cost that affects Gross Margin, usually in the Other Cost of Sales area, or as an Operating Expense; the accountants are divided on which way is better. Then, Accounts Receivable will be reduced on schedule, the Cash Flow will reflect the outflow from costs and will be impacted corresponding to payment days.

Additional Detail

Bad debt reduces the amount of receivables so in accounting you have to offset the amount written off as uncollected with a matching change in receivables. 

In planning, however, you are predicting the future, not accounting for the past. Your plan wouldn't actually specify which transactions are being written off because you are guessing the future, they haven't happened, you are estimating monthly amounts and not record-based transaction amounts.

Business plans that include bad debt should assume the debts being written off are a subset of the debts being collected, that they will be written off on a similar schedule (60, 90 days, whatever) plus some additional delay equivalent to payment days because you don't write off as quickly as people pay, you hope to collect.

The general rule that, "this is planning, not accounting" applies here. The accuracy of the Cash Flow projections depends so much more on Sales Forecast and larger variables that it's not efficient to spend too much time on this very small variable. A simple estimate is the most practical answer.