Bad debt: meaning, examples, how to write it off and how to prevent it
Bad debt is money a customer owes your business that you no longer expect to collect — an unpaid invoice or account balance you write off as a loss. When you write it off, the amount is recorded as bad debt expense and removed from accounts receivable. A café that closes owing you $1,150 for three months of supplies is a typical bad debt. Below: how bad debt is recorded (direct write-off vs allowance method, with journal entries), how to estimate it, what happens if the customer pays later, the tax angle, and — most useful of all — how to spot a customer drifting toward bad debt early, including with a per-customer ledger such as Account Ledger by Ofisx.
Short answer
- Bad debt meaning: an amount a customer owes you that you have decided you cannot collect.
- Bad debt expense: the cost of those uncollectible amounts, shown on the income statement (profit and loss).
- Debit or credit? Writing off bad debt debits Bad Debt Expense (or the Allowance for Doubtful Accounts) and credits Accounts Receivable.
- Two methods: the direct write-off method records the loss when a specific account is given up; the allowance method estimates expected losses in advance and is required under GAAP when bad debts are material.
- Bad debt ratio: bad debts ÷ credit sales for the same period. $1,150 written off on $96,000 of credit sales = 1.2%.
- Prevention beats write-off: credit limits, written terms, weekly balance checks and early reminders stop most bad debts before they happen.
Bad debt examples for small businesses
Bad debt only exists when you sold on credit — delivered first, got paid later. Cash and card sales cannot become bad debt. Typical cases:
| Situation | Amount owed | Is it bad debt yet? | Why |
|---|---|---|---|
| Pine Street Deli closed and the owner cannot be reached | $1,150.00 | Yes — write it off | No realistic way to collect; reminders and calls failed |
| A contractor customer went bankrupt | $3,800.00 | Usually yes, unless the bankruptcy pays creditors something | File your claim; write off what will not be paid |
| Customer disputes part of an invoice | $300.00 of $2,100.00 | No — it is a dispute | If you agree to reduce it, issue a credit, not a bad debt write-off |
| Customer is 45 days late but still ordering | $4,200.00 | No — it is past due | Collectable; hold new credit and follow up |
| Customer pays $50 a month on a $900 balance | $900.00 | No | Slow, but still paying; agree a written plan |
The line between past due and bad debt is a decision, not a number of days. Many small businesses review anything over 90 days past due and write off an account only when collection efforts have clearly failed.
Direct write-off method vs allowance method
| Direct write-off method | Allowance method | |
|---|---|---|
| When the expense is recorded | When a specific account is judged uncollectible | In the same period as the sales, as an estimate |
| Journal entry | Dr Bad Debt Expense / Cr Accounts Receivable | Estimate: Dr Bad Debt Expense / Cr Allowance for Doubtful Accounts. Write-off: Dr Allowance / Cr Accounts Receivable |
| Effect on the balance sheet | Receivables shown at full amount until written off | Receivables shown net of the allowance (what you expect to collect) |
| GAAP | Acceptable only when bad debts are immaterial | Required when bad debts are material |
| Who uses it | Very small businesses, and US tax returns (see below) | Businesses with audited or lender-reviewed financial statements |
Direct write-off example: you give up on Pine Street Deli's $1,150. Entry: debit Bad Debt Expense $1,150, credit Accounts Receivable — Pine Street Deli $1,150. The customer's balance goes to zero and the loss shows on this month's P&L.
Allowance write-off example: if you had already set up an allowance, the same write-off is debit Allowance for Doubtful Accounts $1,150, credit Accounts Receivable $1,150. No new expense is recorded at that moment — it was estimated earlier.
How to calculate bad debt expense (estimate)
Under the allowance method you estimate the uncollectible part of receivables. Two common ways:
1. Percentage of credit sales: bad debt expense = credit sales × your historical loss rate. $96,000 of credit sales × 1.2% = $1,152.
2. Aging method (percentage of receivables): apply a higher rate to older balances. Example with illustrative rates:
| Age of balance | Receivables | Estimated uncollectible | Allowance needed |
|---|---|---|---|
| Not yet due | $7,000.00 | 1% | $70.00 |
| 1–30 days past due | $2,800.00 | 3% | $84.00 |
| 31–60 days past due | $1,200.00 | 10% | $120.00 |
| 61–90 days past due | $600.00 | 25% | $150.00 |
| Over 90 days past due | $400.00 | 50% | $200.00 |
| Total | $12,000.00 | $624.00 |
If the allowance account already has a $200 credit balance, this period's entry is debit Bad Debt Expense $424, credit Allowance $424, bringing the allowance to $624. Use your own past write-offs to set the rates; the ones above are only an example. The buckets come from an aging report.
Bad debt ratio = bad debts written off ÷ total credit sales. Track it yearly: a rising ratio means your credit rules are too loose.
What if a written-off customer pays later?
It happens — a former customer reopens or a collection agency recovers part of the balance. Record it in two steps so the customer's history stays complete:
- Reinstate the receivable: debit Accounts Receivable, credit Bad Debt Expense (direct method) or credit Allowance for Doubtful Accounts (allowance method) for the amount recovered.
- Record the payment: debit Cash, credit Accounts Receivable.
- Note it on the customer's ledger so their account shows the write-off and the recovery, not a mysterious payment.
Tax angle (US): the IRS generally allows a business bad debt deduction only for amounts you previously included in income — so an accrual-basis business that recorded the sale can usually deduct a worthless receivable, while a cash-basis business that never recorded the unpaid invoice as income generally cannot. Tax returns use the specific charge-off (direct) approach, not the GAAP allowance estimate. Rules have details and exceptions; confirm with your tax advisor before you deduct.
How to prevent bad debt: early warning signs
Almost every bad debt was a slow payer first. Watch each customer's balance, not just individual invoices, and act on these signs:
| Warning sign | What to do |
|---|---|
| Balance keeps growing while payments shrink | Stop raising the limit; ask for a payment before the next delivery |
| Oldest unpaid sale passes the due date by 15–30 days | Send a written payment reminder with the balance |
| Partial "round number" payments instead of paying invoices | Agree a written payment plan with dates |
| Promises without a date, or a new contact person every call | Hold new orders on account; move to cash on delivery |
| Customer disputes old invoices only when asked to pay | Send a full statement of account and confirm the balance in writing |
Before you sell on credit at all, set a credit limit, get the customer's legal name and contact details, and write the terms down — see trade credit and Net 30 payment terms.
Tools that help you catch bad debt early
| Option | Best for | Spotting slow payers | Bad debt write-off | Platforms | US App Store ratings (Oct 21, 2026) |
|---|---|---|---|---|---|
| Account Ledger by Ofisx | Small businesses that sell on account to regular customers | Running balance per customer; due-date alerts for upcoming and overdue amounts | No accounting entry — record it as a note or adjusting line on the customer's ledger | iPhone (US App Store); Android on Google Play in Turkey only | New in the US store — no ratings yet |
| Intuit QuickBooks | Businesses that run full accounting in QuickBooks | A/R aging reports and invoice reminders | Write off invoices to a bad debt expense account | iPhone, Android, web | 273,010 ratings, 4.7 |
| Zoho Books | Small businesses invoicing in Zoho | Aging reports and payment reminders | Write off invoices as bad debt | iPhone, Android, web | 5,264 ratings, 4.8 |
| Wave | Very small businesses that invoice in Wave | Overdue invoice reminders | Through its bookkeeping (journal transactions) | iPhone, Android, web | 6,665 ratings, 4.4 |
| Spreadsheet | A handful of credit customers | Days past due column and a filter | By hand, plus a note to your accountant | Any | — |
The options in detail
Account Ledger by Ofisx
Account Ledger keeps a ledger per customer — sales on credit with a due date, payments, partial payments and returns — and shows each customer's running balance, so a growing balance is visible before it becomes bad debt. Due-date alerts flag overdue amounts, and from the customer's card you can send their balance by WhatsApp or share the ledger as a PDF statement.
It is not double-entry accounting: it has no allowance account, no bad debt expense report and no tax forms. Give your accountant the written-off balances from the ledger.
Intuit QuickBooks
QuickBooks handles receivables inside full double-entry accounting, including aging reports and writing off uncollectible invoices.
Zoho Books
Zoho Books offers receivables aging, reminders and invoice write-offs in full accounting.
Wave
Wave combines invoicing and bookkeeping; uncollectible invoices are handled through its accounting records.
Spreadsheet
A sheet with customer, invoice date, due date, amount, paid and balance works for a few accounts. It breaks down with partial payments and when you need each customer's total balance quickly.
How to keep bad debt low
- See every customer's total balance — Bad debt grows one small invoice at a time. A client ledger shows the total at a glance.
- Set a credit limit for each account — Decide the maximum you are willing to lose before the first sale on credit, and raise it only after on-time payments.
- Check past-due balances weekly — A 10-minute weekly review catches slow payers while they are still collectable.
- Remind early, in writing — A friendly reminder before the due date and a firm one soon after recovers more than a call at day 90.
- Stop credit, not the relationship — Moving a late customer to cash on delivery protects you without losing them.
- Keep records your accountant can use — Dates, amounts, reminders sent and the decision to write off — all needed for the books and any tax deduction.
Limits — what Account Ledger does not do
- Account Ledger is not double-entry accounting: no allowance for doubtful accounts, no journal entries, no bad debt expense report.
- It does not send automatic email reminder sequences, use a collection agency or take card payments; you send the WhatsApp reminder from the customer's card.
- In the US the app is on the App Store for iPhone; the Android version is on Google Play in Turkey only for now.
- It is a paid subscription after the free trial; the App Store shows current plans and prices.
Frequently asked questions
What is bad debt?
Bad debt is an amount a customer owes your business that you have decided you cannot collect, such as an unpaid invoice from a customer that closed. It is written off as bad debt expense.
Is bad debt a debit or a credit?
Bad debt expense is a debit. With the direct write-off method the entry is debit Bad Debt Expense, credit Accounts Receivable. With the allowance method the estimate is debit Bad Debt Expense, credit Allowance for Doubtful Accounts, and the later write-off is debit Allowance, credit Accounts Receivable.
Where does bad debt expense go on the financial statements?
Bad debt expense goes on the income statement (profit and loss), usually under operating or selling, general and administrative expenses. The allowance for doubtful accounts appears on the balance sheet as a reduction of accounts receivable.
What is the difference between the direct write-off method and the allowance method?
The direct write-off method records the expense only when a specific account is judged uncollectible. The allowance method estimates uncollectible amounts in advance, in the same period as the sales, and is required under GAAP when bad debts are material.
How do you calculate bad debt expense?
Either multiply credit sales by your historical loss rate (for example $96,000 × 1.2% = $1,152), or use the aging method: apply higher loss rates to older receivables and add them up to get the allowance needed.
When should I write off a bad debt?
When collection efforts have clearly failed — the customer cannot be reached, has closed, or a bankruptcy will not pay — rather than after a fixed number of days. Many small businesses review balances over 90 days past due.
Can I deduct bad debt on my taxes?
In the US a business bad debt is generally deductible only if the amount was previously included in income, which usually means accrual-basis businesses; cash-basis businesses generally cannot deduct unpaid invoices they never reported as income. Confirm with a tax advisor.
How can a small business prevent bad debt?
Set a credit limit per customer, agree terms in writing, check each customer's balance weekly, remind before and soon after the due date, and stop new credit for late accounts. Accounting apps such as QuickBooks, Zoho Books and Wave do this for invoices issued in them; Account Ledger by Ofisx keeps a running-balance ledger per customer with due-date alerts on iPhone, with a free trial and then a subscription.