It is all too easy for finance to review the provisions when monthly or quarterly accounts are being finalized, and if the profit figure at the bottom is smaller than expected, the person responsible will look for some soft targets to increase the reported profits in line with expectations. If you think this couldn’t happen ask your financial accountant if it could!
In my tenure as Credit Manager, I owned the provision figure as much as I owned the ledger balance and any changes had to be agreed with me first.
The reality is that in your medium to large Company, if there is a significant bad debt, the first question that will be asked is “Is it provided for?” – If it is there will be no serious repercussions, if it isn’t and that amount will hit the reported profits of the current month, then you have a problem of a completely different scale. News of the loss will be debated hotly in the boardroom as it has ruined the whole months figures and when that happens someone will come looking for someone to blame. Any ideas who that might be? Probably not the sales person!
If you have a Credit Policy, and you should, you should have a clear outline of your provisioning policy. You should have specific provisions against specific balances you know are very high risk. You should also have a general provision with agreed %, preferably split between high, medium and low risk accounts. You need to look at previous performance, your current ledger risk profile and the market conditions in each industry sector in arriving at your figures. You should also take into account the age of the debt. The Credit Management Handbook tells us that we can expect to get 80% of debts more than 60 days overdue, 50% of debts more than 180 days overdue and only 10% of debts more than 360 days overdue, this can be used as a simple rule of thumb to give you a starting point in building accurate provisions.
You should also have some trigger for writing off old balances you know you will never get. Too often I see balances four or five years old still on the ledger and worse still they are still printing and posting statements to them on a monthly basis adding cost to an already lost cause.
You should get some third party opinion before you write off old balances (maybe from The Credit Coach!), if there is one thing worse than keeping a balance on your ledger too long and that is writing off a balance that is collectable, if a different approach is taken.
There is a wealth of services available to you through The Credit Coach to help you make informed decisions every time. The information is there and it is in your own interest to use it.
If you do nothing else having read this article, have a look at your current bad debt provisions and see how they compare to last years write offs, and ask your self are they realistic.