Bad Debt Provision
Bad debt provision is an appropriation of profits or an allowance for doubtful debts that is made by a company to cover losses on accounts receivable. Its the amount of money that a business sets aside when it is expecting that some of its debts or accounts receivable will not be collectible. It is an expense for the company and affects its net income for the period in which the provision is made.
Bad debt provision is a necessary measure that companies must take to ensure the accuracy of their financial statements. The accepted accounting technique is to estimate the allowance for doubtful debts by using historic information regarding how much bad debt the company has had in the past. The purpose of making such an allowance is to ensure that the company’s accounts receivable essentially represents cash that can be collected.
When creating a bad debt provision, its amount is calculated as a percentage of total accounts receivable. There is no one standard rate of provision that is applied across different companies. A company may invest time in researching its bad debt history to identify the percentage rate at which bad debt allowance should be applied.
Aside from its effects on the company’s accounts receivable and financial statements, bad debt provision also affects the cash flow of the company. When a company makes provision for doubtful debts, it reduces its operating profits and that has a knock-on effect on the cash flow of the company. A company must weigh the advantages and disadvantages of making a higher or lower provision for doubtful debts. On the one hand, a high provision allows the company to be conservative in keeping its accounts receivable in check, but it may reduce the cash flow of the company. On the other hand, a low provision may not be sufficient in catching up with the bad debts and could lead to a lower level of accuracy in the financial statements of the company.
In conclusion, bad debt provision is an important tool used by companies to measure and predict bad debt in order to keep their accounts receivable accurate and up-to-date. It is important to weigh the advantages and disadvantages of a higher or lower provision in order to maximize the cash flow of the company while also ensuring that the financial statements of the company are accurate.
