3 Things To Know About Bad Debt

3 Things To Know About Bad Debt

The Financial Dictionary defines Bad Debt as “Debt from a credit sale that the creditor is unable to collect. Debt becomes bad debt when the creditor has made all reasonable efforts to collect the debt but has been unable to do so. Often, this occurs when the debtor declares bankruptcy or when pursuing collection attempts further will cost more than the debt itself. A company writes off bad debt as an expense, which reduces its taxable income. However, it also deprives the company of cash flow that is ultimately necessary to keep it in business”

For financial institutions bad debts are debts from bank asset (money borrowed to customers) that the customer is unable or unwilling to pay back or fulfill repayment obligations for a particular period of time often over 9 month. It mean collections for up to 9 months remain unpaid or uncollected. Such debt becomes bad debt and it is written off against the banks books.

Here Are 3 Things To Know About Bad Debt

1. Bad Debt are written off against the bank books

Once a loan goes bad, the bank is expected by law to write it off against its books. This mean the bank must use part of the profit it makes from other customers that pays their debt as at when due to provide for the loan of the customer that is not fulfilling his loan obligations. This invariably reduces the banks profitability and shareholders will have less returns on their investment

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2. Bad Debt destroys the credibility of the debtor

A customer with Bad Debt automatically looses his credibility in the financial system. The bad debt no matter how small the amount is automatically disqualifies the customer from being able to access loan facilities in any financial institution unless cleared. The various credit reports prepared by all financial institutions at the point of loan applications will show that the customer has a bad credit in a financial institution and the loan request will be turned down. This is as mandated by regulations and unless the customer is cleared by the reporting bank.

3. Bad debt affects the credibility of the bank

A bank with a large bad debt portfolio can have its credibility trampled. The bank’s management will have to explain to its shareholder and the public why they have to write off the much they did. Is it a result of economic factors or incompetence of the management.

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