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What to do with bad debts

If you’ve been chasing unpaid invoices and its looking highly unlikely that you will ever receive payment then perhaps it’s time to consider whether you should write it off as a bad debt.

Under normal circumstances, you have to physically record the invoice as a bad debt in Xero before the end of the financial year. However, due to Covid, Inland Revenue have extended the deadline for writing off bad debts until 30 June 2020.

How to decide if a debt is ‘bad’

Fundamentally, a debt is considered bad when you as a “reasonably prudent commercially minded person” come to the conclusion that the debt is unable to be recovered based on the following factors:

  • The period the debt has been unpaid – it’s reasonable to assume that the longer the debt has been outstanding, the less likely it is to be paid.
  • Steps you’ve taken to collect the debt – how often have you chased the customer? Have you tried using a debt collector?
  • Your knowledge of the debtor’s financial position – have you heard that other businesses aren’t being paid or are there other indicators that the debtor is in financial difficulty?
  • Whether the debtor is deceased, cannot be traced or is in receivership or liquidation.

If, having weighed up all these factors, you come to the conclusion that there is no chance of recovering any money then you're able to write the debt off in Xero

Covid-19 Considerations

While Inland Revenue have extended the time period for writing off bad debts, you can only take into consideration information that was available and relevant at the end of your financial year.

Inland Revenue has also advised that you cannot write off the debts as bad by the end of the 2020 income year as a result of the impacts of Covid-19.

This means that even though you might have customers who closed their doors and ceased trading due to Covid-19, you’ll have to wait until the 2021 income year to write their debts off.

Prevention is better than cure

Obviously, it’s always best to try and avoid bad debts in the first place. Some preventative measures you can take include:

  • Completing credit checks on new customers, particularly if you’re offering a sizeable about of credit.
  • Offer alternative payment methods such as credit card payments or instalment plans can help keep the money flowing.
  • Request deposits or payment prior to delivery to help minimise risks of non-payment.
  • Keep on top of your debtors. If your terms say payable on the 20th of the month, make sure you follow up within 3 days if you haven’t been paid. Continue to follow up until you get a commitment to be paid, and actually receive the cash. Remember the squeaky wheel gets the oil.
  • Use a debt collection agency. Sometimes you just need to get the professionals in.  Obviously use your judgement based on the customers situation, but don’t feel bad if you decide to use debt collectors. You have provided a product or service as mutually agreed and it is reasonable for you to be paid.  

If you need assistance in deciding whether a debt is bad, how to write off bad debts in Xero, or how to chase up slow payers we're more than happy to help.