What Is A Bad Debt Reserve (Allowance for Doubtful Accounts)?
A bad debt reserve, also known as an allowance for doubtful accounts (ADA), is when a company ties up large sources of capital to protect themselves from loss. It’s the total amount of receivables the company never expects to collect.
With trade credit insurance, a different form of protection against loss, companies can deploy their capital where it’s needed most—to support their growth and innovation.
When deciding how to best protect your business from loss and non-payment, it’s very important to consider your options before making a decision.
Are Allowances for Bad Debts a Good Idea?
One common area where companies fail to evolve is in continuing to own their own risk when it comes to insuring their accounts receivable. In these instances, business owners agree to accept the loss of any unpaid invoice amounts, plus the full costs required to manage their internal credit grading processes. These businesses use a bad debt reserve to offset losses, research customers of their own and own all the risk internally.
Self-insuring by using bad debt reserves may come without a direct cost, but it offers limited benefits in the event of a catastrophic loss. Remember, unpaid invoices weaken your cash flow and those additional costs will add up quickly. Utilizing an allowance for doubtful accounts if a customer doesn’t pay also requires more internal resources to manage the risk. Use the comparison chart below to see how much you might be costing your business.