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It’s so exciting! You make a sale and you have dollar signs in your eyes. But sometimes those dollars never actually make it to your bank account. You have Bad Debt, and that can be as ominous as it sounds. How do you deal with it?
First, we have to consider your reporting method. Do you report your income on a Cash Basis or Accrual Basis? Let’s look at those differences first because you will treat the Bad Debt differently depending on your basis.
If you are a Cash Basis entity, that means you don’t recognize your income until you have the Cash in your hand. Or bank account. Or pocket. If you sold something in January but didn’t get paid until June, your income happens in June, not January.
If you are an Accrual Basis entity, that means you recognize the income the instant it happens, whether you have the actual money yet or not. So if you sell something in January, but don’t get paid until June, your income happens in January.
So what happens if you never get paid? That depends on your reporting method.
If you report on Cash Basis, you don’t have Bad Debt.
But wait! I didn’t get the money! What do you mean I don’t have Bad Debt?
Because you report on Cash Basis, you have never recognized this amount as income. Remember, the money has to be in your hand to be income. If it’s still in your customer’s pocket, it was never your income. So you have nothing to deduct. No income, no bad debt. The easiest way to deal with this situation is to simply void the invoice. By voiding it, you still show it in your books, just with a -0- balance. You have the ability to write notes or memos on the invoice. Maybe something like, “Deadbeat! Refused to pay!” That could help you remember not to give this fellow credit some time in the future.
If you report on Accrual Basis, you do have a debt to write off. You recognized that income when you wrote the invoice, but you don’t have the money and you’re sure you’ll never get it. This is a Bad Debt. Here are the steps that make it nice and easy to remove this amount from income and turn it into an expense.
First, create an account of the type EXPENSE and call it Bad Debt Expense.
Now, go to your Products/Services list and create a Product (Non-inventory or Service is fine), and call it Bad Debt. You can also add something in the description if you like. Don’t put an amount because it may be different the next time you have to use it. Point that Product to the Bad Debt Expense you just created.
Next, create a Credit Memo for that customer in the amount of the invoice you’re writing off. Use the Product Bad Debt on the credit memo form. If Quickbooks doesn’t automatically apply the credit to the invoice, you can easily click the boxes in the Receive Payment window. Now that customer’s balance should be zero. You’ve applied the credit to the original invoice.
Even though you still have the income from the original invoice, you have a credit memo offsetting it which shows up in the Bad Debt Expense. The net effect of these two transactions is zero – Money into Income from your invoice, expense from the Bad Debt credit memo. The two transactions cancel each other.
Wait. Why can’t I just void the invoice like we did for Cash Basis?
You can if both transactions are in the same tax year. But if the invoice was in 2022, you’ve already paid the taxes on that income. If you void it in 2023, your tax return will no longer match your books, and you won’t get the tax relief created by the Bad Debt expense. So use a credit memo in the current year to reduce your income and magically also reduce your tax liability.
Gee, that’s a lot of work. I wish I didn’t have to worry so much about Bad Debt Write-offs.
Believe me, we all wish that. What’s the very best thing you can do to make sure your invoices get paid? Make it easy for your customers to pay them. Studies have proven that invoices emailed with a “pay now” link get paid twice as fast as invoices sent through snail mail. QuickBooks can send your invoices to your customers, offer a payment link, and send reminders from gentle to stern at your choice and at the intervals you prefer.
We live in the App Friendly Technology age. Apply it to your own finances and make it easy for your customers and yourself. Make Bad Debt go away and put those dollar signs in your bank account where they belong.