When calculating your general provision you can either look backwards or look forward.
Looking back you calculate the % of bad debts you have had over previous years. Whatever figure you had last year, indicators are that it will be higher this year. If you had a write off level of 0.8% last year, it would be prudent to accrue 1% this year. This figure should be calculated on the basis of your existing sales, so if your turnover is down you could end up with a smaller provision
When looking forwards you can look at your current balances and there are a couple of ways to make a calculation. You can look at the different aging columns and assign a percentage to each. In broad terms if the money is within terms you can expect to get all of it, if the account goes beyond 60 days beyond the due date you can expect to collect 80% of it. If the account goes beyond 180 days you will probably get half, and if it goes beyond one year you are down to around 10% collection rate. These percentages can be applied as well as or in addition to your general provision.
Looking forwards you can look at each balance individually and based on the risk profile you can decide on a percentage assigned to each, based on age and value.
You can then create a matrix – rather than looking at an overall figure of say 0.8% you can base your provision as 2% of high risk customers, 0.6% on all the medium risk, and say 0.2% on all low risk accounts, or whatever percentages are appropriate you your business based on previous performance.
In calculating your specific provision you are best to focus on the high risk accounts. For this exercise you have to go through each one, if in doubt ask yourself would you personally buy that debt at face value. If the answer is “No” chances are you should create some level of provision to offset your exposure.
If you are taking on a new high risk customer for whatever reason, it is a good idea to start providing at the start. You could divert a portion of the nominal profit to your bad debt provisions for a set time and only stop the provisioning procedure when the amount you have accrued exceeds the value of potential exposure.
Make no mistake, as the person responsible for credit; you are also responsible to ensure there is an adequate provision in place. When there is a bad debt the first question that is asked at board level is “Is it provided for?” If the answer is yes it will have much less serious implications than if the answer is no.
When accountants are preparing monthly or quarterly accounts and are under pressure to show a profit figure in line with the budget they often look for soft targets where they can reduce expenses to show the required profit. In accounting terms the Bad debt Provision is treated as an expense, and if your provisioning criteria are not written in stone, this figure can be an easy target. When you manage your function correctly, it is just as important to manage your boundaries, take responsibility for this important function that has the potential to cause you real grief, in the current climate there is an acceptance of bad news so get all the bad news into the public domain as soon as you can.