Legal Definitions - bad-debt loss ratio

The bad-debt loss ratio is a financial metric that indicates the proportion of money a business is owed by its customers that it ultimately fails to collect. It is calculated by dividing the total amount of uncollectible debt (bad debt) by the total amount of money customers owe the business (total receivables) over a specific period. This ratio helps businesses understand the risk associated with extending credit and the effectiveness of their collection efforts.

• Example 1: A Local Landscaping Business

  Imagine "Green Thumb Landscaping," a company that provides services to residential clients and typically bills them after the work is completed. Over the course of a year, Green Thumb Landscaping bills its clients a total of $200,000. However, due to a few clients moving away without paying or simply refusing to settle their invoices, the company determines that $8,000 of that billed amount is uncollectible. In this scenario, Green Thumb Landscaping's bad-debt loss ratio would be $8,000 (uncollectible debt) divided by $200,000 (total receivables), resulting in a 4% bad-debt loss ratio. This ratio helps the owner understand the financial impact of non-paying clients and might prompt them to adjust their billing practices or client screening.

• Example 2: An Online Software Subscription Service

  Consider "CloudFlow," a company that offers monthly subscriptions for its project management software. CloudFlow bills its 10,000 subscribers a total of $500,000 each month. Despite automated billing and reminder systems, some subscribers' credit cards expire, or they cancel their service without paying their final outstanding balance. In a particular quarter, CloudFlow identifies $10,000 in unpaid subscription fees that are deemed unrecoverable. Their bad-debt loss ratio for that quarter would be $10,000 (uncollectible debt) divided by $1,500,000 (total receivables over three months), which is approximately 0.67%. This low ratio suggests effective billing and collection processes, but it still represents a measurable loss that the company tracks to maintain financial health.

• Example 3: A Wholesale Food Distributor

  "Harvest Provisions" is a large distributor that sells groceries and produce to restaurants and grocery stores on credit terms, meaning customers pay within 30 or 60 days of receiving goods. At the end of their fiscal year, Harvest Provisions has $10 million in outstanding invoices (total receivables) from its various business clients. After reviewing their accounts, they identify that several small restaurants they supplied have gone out of business, leaving $300,000 in unpaid bills that are now considered uncollectible. Harvest Provisions' bad-debt loss ratio for the year would be $300,000 (uncollectible debt) divided by $10,000,000 (total receivables), resulting in a 3% ratio. This figure is critical for Harvest Provisions to assess the risk of their credit policies and to set appropriate pricing for their products to cover potential losses.