When you want to land investors or determine where your company is headed, you need to navigate some treacherous financial waters. This requires a financial forecast, lest you be lost. But wait, what’s this? A storm lurks ahead! The clouds are blocking your view and you have no idea where you’re headed. The name of those clouds? Uncollectible accounts and bad debt. Argh, these be the nastiest of storms.
It’s an unfortunate truth in business that not all your clients will pay their bills. Unless you only deliver your product or service after payments are rendered, you’re likely to have a few clients that won’t pay what they owe. These uncollectible accounts have virtually zero chance of being paid off, making them bad debt through and through. Investors may not mind some debt, but bad debt? That’s a big no no.
So what’s a business owner to do? You can’t turn away all business out of fear. Like a looming storm, the best thing you can do is prepare for bad debt and uncollectible accounts. Using the percentage of sales method, you can do just this and determine what percentage or amount of bad debt needs to be built into your finances.
It’s time to learn how to maintain correct financial statements and accurately forecast revenue by accounting for these bad debts in your budget with the percentage of sales method. But first let’s look at what an allowance is. (No, not the kind your parents gave you.)