Calculating Net Receivables (Bad Debt Expense) Definition and Calculation

Net receivables (Bad Debt Expense) represent the total money owed to a company by its customers minus the money that will likely never be paid. In other words, it’s the amount a company can realistically expect to receive from its outstanding customer invoices. The formula for calculating net receivables (bad debt expense) is straightforward:

Net Receivables = Accounts Receivable -Allowance for Doubtful Accounts - Allowance for Sales Returns

Here’s what each component means:

• Accounts Receivable: The total amount of money customers owe to the company.

• Allowance for Doubtful Accounts: An estimate of accounts that may not be fully collectible.

• Allowance for Sales Returns: An estimate of potential returns due to product defects or dissatisfaction.
  

Collecting Net Receivables:

Typically a company will actively attempt to collect past due receivables after they've lapsed a set period such as 30, 60 and 90 days. Collection methods include dunning letters, phone calls, referrals to collection agencies and in some cases lawsuits. Inevitably, some collection attempts will be unsuccessful, creating a bad debt expense.

When a company uses accrual accounting, it cannot simply post a bad debt expense due to the matching principle of GAAP accounting. These companies normally estimate their uncollectible accounts at the start of the period and post the estimate in the allowance for doubtful accounts, a contra asset account that reduces accounts receivable. A Journal Entry to Credit A/R and Debit Contra Doubtful Accounts at the beginning of the period is created.

Three common methods for estimating allowance for bad debt include:

1. Percentage of accounts receivable

2. Percentage of sales

3. A/R aging as a percentage of the most delinquent account

The accounting process to recognize bad debt is as follows:

1. Accrual Accounting: Create a Bad Debt Item and Bad Debt Expense account. The Write off will be a Credit to Contra Doubtful Accounts and Debit to Bad Debt Expense at period end, applied to each customers unpaid invoice

2. Cash Accounting: Create a Bad Debt Item and Bad Debt Expense account. Enter the write off for the bad debt expense by issuing a Credit Memo for the amount of the write off and apply it to the unpaid invoice.

Understanding net receivables is crucial for managing cash flow effectively. By monitoring these figures, businesses can make informed decisions, maintain financial stability, and plan for growth. So, the next time you analyze your company’s financials, pay attention to those net receivables—they hold valuable insights!

Calculating Net Receivables (Bad Debt Expense) Definition and Calculation