Turns out even biblical kings knew to write off bad debt before year-end (Matthew 18:21–35)
The Parable of the Unmerciful Servant, Jan Senders van Hemessen, 1556

As C-level executives, you navigate complex financial landscapes where every line item impacts strategic decisions. While bad debt may seem like a routine accounting matter, it’s a powerful lever that, when managed effectively, can enhance financial clarity, optimize tax efficiency, and strengthen investor confidence. Knowing how to handle bad debt is crucial and the answer lies in seeing bad debt as a strategic tool, not a mere accounting footnote.

Accounting - Choosing the Right Method

There are two basic approaches on how to account for bad debt: Direct write-off and allowance method. Nevertheless, the choice is pivotal:

• Direct Write-Off: Simple, but delays risk recognition and lacks GAAP compliance. Suitable only for very early-stage businesses with minimal credit exposure.

• Allowance Method: Estimates future losses, providing a forward-looking view crucial for forecasting and robust financial reporting. It's essential for scaling businesses with recurring credit sales.

Implement the allowance method and update it quarterly, leveraging tools like HighRadius or BlackLine for automation and risk scoring. This ensures accurate, timely financial insights.

Forecasting Bad Debt & Understanding Where It Comes From

Bad debt doesn’t just appear on your books but builds over time through specific patterns: late-paying customers, weak follow-up processes, or poorly structured sales terms. It also reveals business site of the story: how your business qualifies clients, sets incentives, and enforces discipline.

To manage this risk proactively, companies need an aging model - a tool that organizes receivables by age (e.g., current, 30, 60, 90+ days overdue) and assigns risk based on how long invoices have been outstanding. It helps transform receivables into a working forecast of future cash and potential losses.

This becomes essential when:

• Credit sales are growing

• Overdue invoices make up a larger share of receivables

• Receivables are a significant part of current assets

• Investors or lenders are scrutinizing your financial hygiene

Aging models are especially helpful for:

• Businesses managing expanding credit exposure

• Businesses with diverse customer types or payment terms

• Companies in high-risk sectors with longer billing cycles

Implemented well, an aging model supports more accurate forecasting, prioritizes collections, and informs policy changes. It also improves external reporting: when you can show investors, auditors, or board members structured oversight of your receivables, your financials and forecast gain credibility.

There is no need for sophisticated tooling to start. Many ERPs already include basic aging reports. A spreadsheet can suffice in early stages. Over time, layering predictive analytics helps optimize it further.

Tax Deductibility: What Qualifies and Why It Matters

Moving on to tax deductibility - when handled correctly, bad debt can reduce your taxable income. But to be deductible, it must meet certain conditions:

• The revenue was previously recognized

• The debt is wholly or partially worthless

• Collection efforts are documented

• The write-off is recorded in the correct fiscal year

Partial write-offs are allowed if properly supported. This matters especially for high-value receivables where partial recovery may still be possible.

Strategic Insight: Review aged receivables before year-end. Well-timed write-offs reduce tax exposure and improve your balance sheet ahead of audits or fundraising.

Strategic Use of Write-Offs

Write-offs are often seen as reactive. But when used intentionally, they become a financial planning tool.

In high-income years, they can reduce tax liabilities. In investor or audit cycles, they help present a cleaner balance sheet and more realistic working capital position. Cleaning up old receivables also improves KPIs like Days Sales Outstanding (DSO) and strengthens reported EBITDA.

In contrast, lingering bad debt signals a lack of control. It artificially inflates assets and erodes trust in your numbers. Addressing it proactively demonstrates maturity and credibility: two things that matter during investor due diligence.

Final Note

Bad debt is part of doing business when you sell on credit. But when unmanaged, it clouds your forecasts, weakens your margins, and sends the wrong signal to stakeholders.

Handled strategically, it becomes a source of control. It enables better reporting, sharper tax positioning, stronger investor confidence, and clearer operational decisions.

For growing companies, managing bad debt well is more than hygiene - it’s a hallmark of financial maturity.

Citations:
https://www.semanticscholar.org/paper/5d2c52ce5d8a23f57d598b184c3a708b34e91594
https://www.semanticscholar.org/paper/091d04812a5f25b872232e1c8c731a77f7d43bc5
https://www.semanticscholar.org/paper/1a872e062b0f0ee38fc73ac695e2e582a3878da0
https://www.semanticscholar.org/paper/552dd675f8f26d45ef07db5f3085da324d2eac9b
https://finance.cornell.edu/accounting/topics/revenueclass/baddebt
https://pro.bloombergtax.com/insights/federal-tax/deducting-business-bad-debt/
https://www.myob.com/au/resources/guides/accounting/bad-debt
https://blog.taxact.com/tax-deductions-non-business-bad-debts/