Question

D.Q. 4.4. Why is it important for businesses to | forecast (predict) their bad debts for an upcoming cycle?

Answer 1

It is important for a business to predict their bad debts and keep a check on them because of the following reasons:

1. An insolvent debtor or a debtor from which payments are uncertain (i.e. reported as bad debts) needs to be identified so as to avoid any future sale of goods on credit to such debtors because they are already unable/unwilling to pay their debts and any further credit sales can increase the amount of bad debts.
2. Debtors are the most crucial current asset of a business, especially to determine liquidity of the business. If the bad debts are not predicted in time and necessary adjustments are not made, it may result in over estimation of trade debtors. But as soon as business gets in its difficult times, the overestimated liquidity can badly affect the business and even the going concern assumption.
3. The working capital loans are granted on the basis of stock and debtors. If we are not regular in predicting the bad debts of the business, the reliability of the debtors will decrease and may create difficulties to obtain a loan for working capital requirements.
4. The bad debts are an integral part of any business. It is more ethical and generally acceptable to predict and report bad debts on regular basis rather than to report bad debts when a debtor becomes insolvent.