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The Paradox of a Bad Debt – Five Fun Facts

It’s that time of year (again) when you have to decide whether you should “take the hit” and write-off that bad debt and (subject to complying with ATO requirements) claim a deduction OR keep chasing the debtor.

You can do both of course, but often once the debt is off the books and not front of mind, you will probably give up the chase and just get on with business.

We are often astounded by the number of Clients who “take the hit” because the recovery has become a bit difficult, the debtor raises non-relevant issues that cause delay or because they fear ever increasing costs with no guarantee of recovery (especially if the debtor ends up insolvent).

All of those reasons are valid and often those decisions are made in the heat of the moment and without careful consideration of all of the facts…

 

Fact One

Writing off a bad debt always costs you money. Yes, you get a deduction but the dollar value of that deduction is not the full dollar value and only a percentage depending upon your tax bracket.

 

Fact Two

When you write off a debt, your write off amount comes straight off the bottom line. Even worse, often people don’t even consider what they need to generate in revenue to get back to that pre-write off position.

A quick example. Your margin is 10% – i.e., for every dollar you generate in revenue, you can expect to net 10% profit. You write off $10,000.00. You will need to generate $100,000 in revenue just to get back to where you were before the write off.

If we said to you we wanted to purchase $100,000.00 of your goods you would be on our doorstep immediately. Clients can write off that amount and not blink, not realising what they need to do to get back to where they started.

 

Fact Three

Often a bad debt is avoidable. You do not have to go through the stress of not getting paid. If you are well set up with proper documentation, a proper policy and process then you can mitigate your risk. Here’s where the paradox comes in.

Often we are complacent, our bad debts are minimal and we have always done things a certain way with no problems. The need for change seems unnecessary – why change something that is not broken?

It is only when the inevitable day arrives that the penny drops. “If only…”, “Why didn’t I…”, “Surely not..” are the cries we hear when that bad debt finally comes home to roost. Every business will experience bad debts at some stage, so the trick is, be like the Scouts, and be prepared.

 

Fact Four

Sometimes that bad debt can send you broke. This is the most important Fact of all. That big Customer that you sell most of your product to, that account where the Customer keeps getting bigger and bigger and the DSO’s keep expanding, those promises that are almost never kept. At some stage you need to give those Customers a reality check – are you going to pay? If not, why not? If so, when?

 

Fact Five 

If your business is not performing as well as what it should, take some action. We see businesses that struggle and it is not a good place to be. Morale is down, there is never enough money to pay anyone when they should, there are angry suppliers and others making constant demands on money. Cash flow can just dry up. 

Business should be enjoyable, a place where you can live out your dreams. Don’t let your life be highjacked by those that want to use your business to grow theirs. EOFY is a great time to start making those essential changes that can ensure you have a business that thrives.


 About the Author

Natalie Ledlin is the Practice Director of Ledlin Lawyers, a boutique legal firm of specialist credit, insolvency and business lawyers. For more information, go to www.ledlinlawyers.com.au