Cost of Bad Debt and Slow Payment
Written by Andy Li CM MCCMA
Most enterprises have to give credit to their customer for getting more business. Proper credit control is essential for two fundamental reasons:
- To avoid bad debt; and
- To ensure the cash inflow from the account receivable outstanding.
Slow payment will increase the operating cost for the business. An invisible cost we always ignored is interest. If we maintain a better control on our AR, we may decrease our credit amount from the banker. The cost of slow payment as showed:
No. of days late |
Interest Rate (%) |
Annual Sales |
|
$100,000 |
$500,000 |
||
30 |
4 |
$329 |
$1,644 |
7 |
$576 |
$2,877 |
|
10 |
$822 |
$4,110 |
|
45 |
4 |
$494 |
$2,466 |
7 |
$863 |
$4,315 |
|
10 |
$1,233 |
$6,165 |
|
90 |
4 |
$987 |
$4,932 |
7 |
$1,726 |
$8,630 |
|
10 |
$2,466 |
$12,329 |
|
On the other hand, if a bad debt occurred in a business, the cost is depended on the pre-tax profit rate on sales. For example:
The amount of bad debt |
Pre-tax profit % on sales |
|||
3% |
10% |
15% |
18% |
|
Extra sales required to offset the bad debt |
||||
$5,000 |
$166,667 |
$50,000 |
$33,334 |
$27,778 |
$12,000 |
$400,000 |
$120,000 |
$80,000 |
$66,667 |
$36,000 |
$1,200,000 |
$360,000 |
$240,000 |
$200,000 |
If the bad debt occurred by a major client, the problem and danger is much more serious for the business.
(All above numbers are aound up to dollar.)
