Bad Debt Forecast
A bad debt forecast is an estimation of the amount of receivables a company expects to be uncollectible due to non-payment by customers. It is used by businesses to anticipate future losses and adjust their accounts receivable accordingly. This helps in maintaining accurate financial records and ensuring compliance with the matching principle of accounting, which states that expenses should be recognized in the same period as the revenues they are related to.
To create a bad debt forecast, companies generally use historical data on past customer payment patterns, industry trends, and economic indicators to predict the potential percentage of uncollected receivables. The forecast may be adjusted periodically to account for changes in customer behavior or market conditions.
Example of a Bad Debt Forecast
Let’s consider a small retail business that sells electronic gadgets and allows customers to purchase on credit. The company has observed that over the past few years, its bad debt rate has been around 4% of its credit sales.
In the current year, the company has made credit sales of $200,000. Using the historical bad debt rate of 4%, the company would create a bad debt forecast to estimate the potential uncollectible amount for the year.
Bad debt forecast = Credit sales × Bad debt rate
Bad debt forecast = $200,000 × 0.04
Bad debt forecast = $8,000
According to the forecast, the company expects to have $8,000 in uncollectible accounts receivable for the current year. To account for this anticipated bad debt expense, the company would record a journal entry to increase the bad debt expense account by $8,000 and increase the allowance for doubtful accounts (a contra-asset account) by the same amount. This adjustment ensures that the company’s financial statements reflect a more accurate representation of the net realizable value of its accounts receivable, taking into consideration the estimated bad debts.