Bad Debt Write Offs; Measuring Bad Debts; Bad Debts as a Measurement of Credit Department Effectiveness

Bad debt write offs are the accounting tool used to reduce the value of accounts receivable by the value of A/R that is considered to be uncollectable.  The purpose of bad debt write offs is to make certain that the company's books and records more accurately reflect the value of its Accounts Receivable.  If bad debts were not written off, the book value of A/R would be overstated by whatever A/R amount was uncollectable and should already have been written off.

Tracking and calculating bad debt write offs as a percentage of sales is one popular method of measuring or evaluating the credit department's ability to monitor and manage credit risk.  The formula used to do so is  Total Bad Debt Write Offs divided by Net Sales expressed as a percentage. 

This formula measures the percentage of sales written off as bad debts for the period under review. To be relevant, bad debts need to be linked with the sales period in which they were generated.  However, this could be very difficult to calculate and could make it difficult to compare results accurately from period to period since percentages in prior periods could change when bad debt write-offs are taken.

• A high percentage is undesirable (although in determining "high," the figure should be compared to the industry and company historical levels);
• Many credit managers use bad debt to sales (percentage) as the key measure of the department's ability to manage accounts receivable.

It should be noted that major sales shifts can affect this calculation by lowering the percentage when sales are high, and inflating [increasing] it when sales are lower.  It should also be noted that there are literally dozens of ways in which the credit department's performance can be measured and monitored.... and because bad debt losses usually occur infrequently, or more specifically large bad debt losses occur infrequently, using bad debt write offs to measure credit department performance is probably not a great measurement tool.  Why?  Because most of the time the credit department will do exceptionally well, and occasionally a significant write off will change performance from good to bad literally overnight.

Edited by Michael Zininberg & Michael Dennis.  Mr. Zininberg is a credit professional with experience measuring, monitoring, managing and collecting from domestic and international accounts.  He can be reached by email at mzininberg@gmail.com