Doubtful debts are any type of outstanding receivables that are thought to be highly unlikely of being settled by the debtor. Many companies make some type of provision for this type of debt when planning operating budgets, typically by allowing for a certain percentage of the average monthly receivables to be considered unlikely of collection. While considered different from bad debts, doubtful debts are sometimes treated in the same manner and may eventually be classed as bad if the balance is not paid and reasonable collection efforts fail.
The criteria used to class outstanding receivables as doubtful debts will vary somewhat, depending on the policies and procedures of the company. Typically, the debt will remain outstanding for a minimum of 120 days after the invoice date. During the period in which collection efforts are made, a debt may be considered doubtful. In some cases, a vendor may consider the current balance due on a client’s account as doubtful debt after learning that the company is undergoing some type of financial trouble that could impair its ability to settle that debt in a timely manner. When a customer files for bankruptcy, any balance on that client’s account that is current considered doubtful debt will be reclassified as bad debt.
In order to safeguard the financial stability of the business, companies typically have some sort of provision or allowance for doubtful debts built into their overall accounting process. This approach makes it possible to monitor the extension of credit to customers who have higher unpaid account balances that have been outstanding for an extended period of time. The measures also help to create a reasonable and typical expectation for cash flow, since debts classed as doubtful are not included in those projections. Doing so helps to minimize financial stress on the business, since the funds are not expected to be available to manage those day to day expenses.
Utilizing a structured qualification plan before extending credit to customers can help to minimize the incidence of doubtful debts. This includes running credit checks on customers from time to time and adjusting payment terms and credit limits accordingly. Monitoring the aging on each customer account will also sometimes provide information that alerts the vendor to an unfavorable trend in the tendering of payments, such as invoices slowly moving from payment within 45 days to past 60 days. By monitoring credit activity as well as invoice aging competently, businesses can help keep the level of doubtful debts within an acceptable range and protect the interests of the company.
