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Bad Debt Percentage

Moneyzine Editor
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Moneyzine Editor
3 mins
September 18th, 2023
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Bad Debt Percentage

Definition

The term bad debt percentage refers to the total amount of accounts receivable that will never be collected from customers. The bad debt percentage is a function of both the company's credit policy as well as the effectiveness of their collections processes.

Calculation

Bad Debt Percentage = Total Bad Debts Recognized / Total Credit Sales

Where:

  • Total bad debts recognized is the dollars the company will never collect from sales on credit. In order to compare total bad debt to credit sales, this value must be annualized to be consistent with the credit sales appearing in the denominator of this formula.

  • Total credit sales is the total of all credit sales in a given timeframe such as the last twelve months.

Explanation

Accounting and finance metrics allow a company's internal analysts to understand how well its accounting and finance departments are operating. This is usually assessed by examining metrics such as error rates, transactions processed, discounts taken, and turnaround times. Accounting and finance metrics allow the company's management team to identify areas where changes can be made that will improve their key operating metrics. One of the ways to learn about the effectiveness of the company's credit policy and collections process is to calculate its bad debt percentage.

A company's accounting, finance and collections departments are usually responsible for determining the policy that allows customers to make purchases on credit. Once a sale on credit occurs, it is the responsibility of the company's accounts receivable and collections teams to manage the dunning processes which will attempt to collect the dollars owed the corporation. One of the ways to measure the effectiveness of these policies and processes is to measure the company bad debt percentage. Since this value will vary by industry, performance should be benchmarked against companies in a similar or the same industry.

Example

The CFO of Company ABC wanted to understand if customers were taking advantage of a recent change in the company's credit policy. The company had received a number of complaints from their customers, stating they were not doing as much business with the company as they could because of its relatively restrictive credit policy. Following a loosening of this policy, the CFO wanted to know if the company's bad debt percentage had risen dramatically and how the company compared to its industry peers.

She asked the company's benchmarking team to procure a global benchmark study, so she could understand the relative performance of the team. The benchmarking group determined top quarter performance was 7.0% of credit sales. Company ABC's information below was found by the team:

Prior Credit Policy

Current Credit Policy

Total Credit Sales

$86,192,640

$99,072,000

Bad Debt

$5,602,500

$6,736,900

Bad Debt Percentage

6.50%

6.80%

While the company attributed much of the growth in credit sales to the new policy, the CFO was pleased to see a relatively small increase in bad debt over the same timeframe. Even more encouraging was the bad debt percentage was still bellow first quartile performance of 7.0%.

Related Terms

Average Processing Time
The term average processing time refers to a calculation that allows a company to understand how much time it takes to process a transaction. The typical transactions examined for this metric include payments to suppliers or invoices issued.
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Best Possible DSO
The term best possible days sales outstanding, or DSO, refers to the lowest possible number of days credit sales are unpaid. A company's best possible DSO is used to benchmark the performance of its credit and collection processes.
Moneyzine Editor
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January 8th, 2024
Aged Receivables
The term aged receivables refers to metrics that state the percentage of receivables that are older than a given number of days. Aged receivables allows a company to understand the effectiveness of their credit policy and collection practices as well as the likelihood a receivable will ever be paid by the customer.
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January 4th, 2024

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