Once again, you have done amazing work for a client and they haven’t paid you. You’ve called them, emailed them and maybe even sent them a message through social media. Maybe, it turns out they can’t afford it, or maybe the project didn’t go well and they are simply not paying.
Whatever the reason, it doesn’t matter. What does matter is they owe you for your time and service and you plan to collect it. The questions you need to ask yourself are how long do you pursue collections, when should you write it off as bad debt, and if you do, how do you do it?
Well, first, let’s back up for a minute and define bad debt. Bad debt is money owed to you as a result of a business transaction and it is now uncollectible. Your customer, again for whatever reason, is not going to pay the balance owed to you. At the time that you discover this, the receivable is deemed worthless.
Many business owners simply leave the balance on the books and never do anything about it because they don’t know how. Now, keep in mind that we are talking about accrual basis accounting. In a cash basis business, there are no receivables and therefore no bad debt.
When the sale occurred, you created an invoice in QuickBooks® Online (QBO). In the backend, the invoice increased your sales and increased your accounts receivable. In the world of accounting, this entry will look like this:
How long should you let this receivable sit on your books?
I typically advise my clients to begin sending gentle email reminders from QBO for two weeks, up to 90 days, after the invoice is due. At the 90-day mark, it’s time to begin assessing if a receivable is collectible or not. Usually, by six months, you know whether you will receive the funds. At nine months, we starting talking about collections, and before we hit a year, we make a move on those collections. Studies show that after one year, the chances of collecting on an outstanding receivable decreases by at least 50 percent, and often times more.
When you are ready to write off the bad debt in QBO, you should follow these steps:
Set Up Your Account
If you do not already have a bad debt expense account in your chart of accounts, you should set that up first. Then, go to products and service under the gear icon and create a service item called bad debt for coding on your invoices. This item should be coded to post to the bad debt expense account.
Credit the Customer
Next, using the quick create icon, create a credit memo for that customer. Use the bad debt item and description in the credit memo to write off the debt. Save the transaction. In the backend, the accounting for this transaction will be an increase to your bad debt expense account and a decrease to your accounts receivable. The entry would look like this:
Apply the Credit
Lastly, go to the customer’s name in your customer list. Select receive payment next to that invoice. Apply the credit against the invoice so that it no longer appears in your aging report. The uncollectible debt will now appear on your profit and loss account under bad debt expense.
Having to write off uncollectible receivables as bad debt can be a pain and frankly annoying. But, leaving it on your books distorts the true financial picture of your business. And, you can’t make good decisions with bad data.