What is Bad Debt and Why It Is Important?

What is Bad Debt and Why It Is Important?

Naturally, debts between the debtors and their respective financing companies need to be settled down immediately when it hits the deadline. This will help the companies to recover their financial capabilities in helping and serving future debtors. Therefore, it is very important that these debts to be settled immediately to ensure that no one will suffer consequences of not paying the debts immediately. However, there are instances where it is not possible to clear the debts immediately because of some technical problems. In finance, this is commonly called as a bad debt.

According to its definition, bad debt is a monetary amount of debt from a debtor that is unlikely to be paid by the debtor. Commonly, this kind of debt happens because of several reasons. The reasons may range from the debtors’ lack of money to pay the debts to the debtors’ financing company suffers its own financial problems. These problems hamper the debt collection or the debt payment process, hence its title as a “problematic” debt. As this kind of debt is sometimes unlikely to be paid by the debtors, financing companies will nonetheless record it in their yearly financial report.

Generally, there are two kinds of bad debts according to financing companies. The first kind of bad debt is known as doubtful debt. This debt is a debt in which the financing companies cannot collect after the deadline has passed. Doubtful debt usually appear in some situations pertaining to the state of the debt itself. Usually, debtors can incite this debt into play when the service that they used from the financing companies is not good enough. Other than that, this debt may arise when the debtors do not have the means to pay the debts immediately. Therefore, this causes uncertainty about whether the financing companies can collect the debts in the end. 

The second type of bad debt is known as doubtful debt reserve. According to its definition, doubtful debt reserve is the money amount of debts that a financing company does not expect to accept. This kind of debt is commonly used as an analysis tool for financing companies to assess its own financial strength. This is because that this reserve is used to ensure that financing companies will not suffer greatly from their debtors’ inability to pay their debts. Hence, financing companies will usually try to ensure the availability of this reserve to brace for unexpected circumstances. 

Despite its title, there are some benefits that financing companies can earn from having bad debt situations. For instance, the financing companies can assess and check their own financial capability in offering debts for the debtors. If the financing companies themselves do not have the means to offer a good deal in this matter, then some things need revising within their services. When there are flaws within their services that may affect their customers’ overall satisfaction, the financing companies can immediately remedy these issues before it is too late. This, in turn, might will help the companies to ensure a more smooth process of debt collection from the debtors.

Other than for self-contemplative reasons, bad debt instances can also serve as a lesson for financing companies in considering their debtors’ behavior. As mentioned before, bad debts can happen because of the debtors’ inability to repay the debts when the deadline hits. Despite reasons such as unforeseen financial spending and its ilk are tolerable because of their sudden appearance, it is impossible that debtors can never pay the debts solely because of these reasons. The debtors’ own recklessness in managing personal finance can also be the potential cause behind their failure to settle the debts. From these circumstances, financing companies can learn how to better themselves in this line of business.

In the end, bad debt is a double-edged sword for financing companies and their respective debtors. Bad debt will cause the financing companies’ capability of debt collection to be hampered because of the debtors’ inability in settling the debts. As the debts are not paid, these companies cannot recover the entirety of financial support that they have given earlier. However, because of this issue, financing companies can solve and fix the issues that probably lie in their own services or in the customers. Despite it is not entirely wise to stack up bad debt instances in the end, it is important for the financing companies to gather all information about these debts for future improvement.

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Author :

Ad Ins

Published date :

10 December 2020