1. The loss is more significant than the write-offs
Write-offs ÷ Net profit margin =
Additional sales needed to offset the write-offs
Once you write an account off, it has a ripple effect throughout your entire organisation. It is not just the balance that is written off, it is the time of the marketing team getting the deal, the time of the sales team closing the deal, the time of the accounting team recording the account, and the time of the collections team chasing the payment.
Besides, many food and beverage companies overlook the fact that in most cases, the cost of bad debts exceeds the written-off accounts. Its impact is twofold: hurting the bottom line with the loss of the monies you are owed, and restraining the growth of the top line.
For example, you write off four outstanding accounts receivable with a total balance of $2,000 and your company has a net profit margin of 5%. To estimate how much sales your company would need to compensate for the bad debts, divide your net profit margin by your write-offs.
Write-offs ÷ Net profit margin = Additional sales needed to offset the write-offs
In this example, writing off the receivables results in your company losing $2,000 and, at the same time, having to make $40,000 more in sales to recover from the loss of profit on the $2,000 write-offs.
Therefore, bad debt expense does not only have to do with the defaulted amounts, but it also has a detrimental impact on your cash flow and impedes the profitability of your company.