Bad debt is when a client is unable to pay your invoice. This can be due to, for example, bankruptcy.
When it comes to accounting, invoices are recorded as debt—money that your client owes you. This is because invoices are sent after a product or service has been delivered, they are what’s called a deferred payment. If the client cannot pay this debt, it’s called bad debt.
This is a loss for your business.
When is an invoice considered bad debt?
Bad debt is essentially any amount of money that you as a creditor must write off when a client is unable to pay.
This happens when your client, whether an individual or a business, demonstrates that they cannot pay what they owe, either partially or at all. If this is due to, for example, bankruptcy, there is no point trying debt collection, and so you can record it as a loss in your accounting.
If, however, it’s not so obvious that you won’t get paid, the government usually requires you to try to collect payment before you can write off the invoice as bad debt. This means sending payment reminders, trying to reach an agreement with the client—such as setting up a payment plan or replacing faulty goods—and even debt collection.
Usually 90 to 120 days have to have passed since the due date before you can write off the invoice as bad debt.
What do you do when an invoice is not going to be paid?
If an invoice is not going to be paid, you have to write off the invoice. This means that you record it in your invoicing software and your accounting software as unpayable. Doing this, means that you won’t have to pay taxes for this money—since you never received it.
It’s also important to write off these invoices, since doing so gives you an up-to-date overview of the financial status of your business: Your reports won’t include money that your business is never going to receive.
This is how to write off an invoice when you invoice with Conta