How to Forecast Bad Debt

A number of variable figures are involved in forecasting bad debt as it is always not certain. It is difficult to calculate bad debt as the figures involved in the calculation keep on changing. In most of the companies the bad debt is forecasted by calculating and gathering the invoices that are not paid or the losses that will occur at the time span of thirty days or a specific accounting period. Another approach is to assign a degree of risk to each customer that is involved in the transactions with the business. The degree of risk can be used to calculate the probability of loss associated with each transaction made by that customer. Hence by calculating the loss that may occur due to transactions a firm can forecast its bad debt.

The steps involve in forecasting the bad debt on the bases of the risk score of the customer can be describes as under:-

  • In the first step the risk scores associated with the customers are collected by the business. All the risk scores are obtained from a third party credit agency such as FICO or D&B score.
  • In the next step a customer master file is created and the risk scores are entered into that file adjacent to the name of particular customer
  • In the third step a spreadsheet is created and the customers are sorted on the bases of their risk scores
  • In forth step the sorted entries of risk scores are divided in quartiles and a risk percentage associated with each customer is then calculated.
  • At the last step the bad debt forecast is made on the bases of calculations provided above

The risk score method is commonly used when the figures associated with bad debt are highly variable and change repeatedly from one season to the other.

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