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Invoice letter example for corporations

let's really get into what bad debt truly is because oftentimes I see folks on social media even some of my former clients they get so comfortable in this idea of what they think accounting and bookkeeping is and they truly miss out on what it entails because they're not doing the work right so to give them some Grace they're not doing the work they don't understand it so let's talk a little bit about defining bad debt bad debt is a debt that becomes worthless because you can't collect on it um and it's only really an issue if you're a corporation that's doing accrual accounting not cash basis accounting okay so with accrual accounting the debt is owed to your business right and it's considered a receivable account you're expecting to receive payment on this account for a particular order for a particular service or product accounts receivable okay and that accounts receivable is listed on your balance sheet as a current asset if you are cash based basis in your business right now you don't have a concern for accrual accounting it is outside of your wheelhouse it is outside of your scope of worries so let's use a good example a very simple example if you charge a client let's say a thousand dollars for coaching services that you performed already and you've entered that transaction into your financial system you should have a financial system okay and the transaction is essentially going into your books as accounts receivable so it counts as a thousand dollars being added to your assets along with cash coming into the bank accounts deposits going into your savings accounts deposits going into your business investment accounts any like inventory or Goods or products that you've purchase to essentially or eventually sell so anything that holds value in your company is an asset okay so even if the balance of the invoice hasn't been paid yet the value of that service that that output of the product is still considered to hold some form of value which is a part of your assets your current assets so let's say the client owes you a thousand dollars but the client goes out of business they go bankrupt um they can't pay their bill that thousand dollars is now considered to be uncollectible and the uncollectibility of that invoice becomes bad debt remember bad debt is worthless you can't collect on it okay so you now have to take the accounting steps to remove that one thousand dollars from your assets and now you have to balance your books here's what folks don't understand about accounting okay so accounting is not just one side of a transaction there's always two sides at a minimum to a transaction so let's say you have a subscription with QuickBooks wave apps freshbook zero it doesn't really matter the software the reason why you don't see those other sides of the transaction is because the software is doing that for you Okay so if you have a thousand dollars coming into your books you just thinking you're non-account exposure you're just thinking like I just have cash come to the bank that's it that's not it you have an increase of cash right if you're accrual if you're doing a cruel accounting you have a decrease in your accounts receivable right so you're touching two areas on your on your um balance sheet you have an impact also on the profit and loss statement which is increasing your Revenue which has nothing to do with the balance sheet okay so just because you can't see it on the surface in accounting there's always multiple sides to a transaction the software is just doing most of the work for you if it's set up correctly to you diy-ers so let's take a little bit of a step into the differences between cash accounting and crew accrual accounting because I think that's important too so let's talk about cash versus accrual accounting it really doesn't matter if you decide to do your own bookkeeping or have someone else do it for you you Outsource it usually there's going to be one of two methods of accounting Cash basis or cruel so the accrual method is anytime you charge let's say a client or customer or some sort of fee you're going to record that fee as income on your profit and loss statement and even if you haven't received the cash yet under accrual accounting you're going to recognize that income on your books okay same thing goes for expenses if let's say you're a graphic designer for example sends you a bill an invoice it's going to be recorded under your accounts payable so I talked earlier about accounts receivable accounts receivable are funds you are expected to pay okay I'm sorry expected to receive accounts payable our funds you are expected to pay out expect it okay so you're going to recognize that bill that invoice that you owe to your your contractor your consultant your attorney right your market research assistant whomever you're expected to pay this bill so you're going to recognize it as an expense but also as a liability a bill that you owe okay once you get the cash into your account right from the client or the customer and you pay the bill you now complete a step in accounting step well the software is completing an accounting step so once you get the cash in hand you pay the bill you're now converting your accounts payable or that accounts receivable to cash it's no longer expected it's already been paid out or received okay now the entire process obviously is more complicated if you're if you're an account you know about t accounts right that's how we learned in school but essentially this is why you need to give credit to accounting professionals Finance professionals that help you to set this up right because you can imagine if you're DIY and you don't have a basic foundational level of understanding of where these amounts are supposed to be hitting whether it's an asset a liability an expense account right an equity account if you're not sure of where these amounts should be hidden you can easily make mistakes very easy because on the surface if you're in a in a in a software a QuickBook software wave apps you're thinking I just need to categorize this because that's what you see on the surface you're not worried about what these dollar amounts what accounts these dollar amounts are touching and if they're correct and that's why when the dollar amounts are hitting these financial statements and the financial statements look crazy like they look completely off that's why because you don't have a foundational level of understanding of the accounting and how it's supposed to look so someone asked me on social media I did a screen share of a sample balance sheet I found on the internet and just walking them through assets liabilities how we get to current assets current liabilities how we get to um Equity all of that I went through a simple balance sheet and someone in the comments asked me I want to do this can I do this without a degree and I immediately went to in my head sure you can but you're gonna need some foundational level of training and understanding Foundation basic okay don't discount what we do okay so let's get back into writing off unpaid services or unpaid products that you you know we're expecting a client or customer to pay for so in the beginning stages many solo entrepreneurs small businesses typically are going to start off with the cash basis method of accounting because it's very simple it's very easy to understand and implement as you as you start to make more money and get you know strategy from your tax Pros your tax strategists you may have to do some conversions of not only your systems but your processes and how you process transactions that's a part of the growth phase so for those of you who tend to just bury your head into the sand and hope that it goes away it's not going to go away the more money you make the more complex that your accounting and your financial management is going to become maybe if so the fact that Cash basis businesses typically start off with this simple method it could take some time to kind of understand the transition from Cash basis to accrual method so you don't necessarily want to get into the weeds of diying you want to get a Reliable Software and a system that's going to be able to do all of these transactions for you in the background because you can imagine how manual this is if you are a high volume business for those of you who have coaching programs academies memberships digital products physical products Chad don't even get into events you can imagine how many transactions that is to make sure that all of these dollar amounts are hitting the correct account and you're trying to do it manually because you think you're saving money you're not I can promise you that so when you have a bad debt on the books your financial records your record keeping manually is not going to catch that your software may catch it but a person a human typically has to fix it okay so that match up and correction and finding is usually called an analysis accounting teams across the country in corporations that you and I have worked in have Financial analysts on their Finance teams to fix and correct these errors at a very granular granular level and a very high level because baby when I tell you these arrows piled up in just 30 days of activity they pile up okay so when clients owe you money right it's being recorded in your AR your accounts receivable is going to appear as an asset on your balance sheet but if the money is not collected it's worth nothing right no value okay it's no longer an asset so we got to get that off the books we got to get that off of your financials so if a bad debt continues to accumulate let's say there's interaction this invoice this scope of work occurred in January if you're on a calendar year balance sheet is going to have an off offset is going to need an offset when that activity occur or when you realize you know we're not going to be able to collect on this it's time to get rid of this and that could be in December at the end of the year so you want to be able to figure out if you're diying know what you're looking at know what you need to capture know what you need to fix and the biggest benefit of doing this is that you don't have to worry about all of these errors piling up throughout the year because the reality is you're not going to have 100 collect uh High collect rate in the beginning stages of your business and the growth stages of your business that's just natural matriculation of people right we get distracted we find service providers who maybe are a better fit we don't uh pay attention like we we we be all over the place as humans so it's just a a a natural part of your business is going to fall off just put just bake it in the numbers even this is five percent ten percent twenty percent a natural part of your business is going to fall off um unless you're an attorney I probably I don't see attorneys having an issue um but even if you have like collection agencies to collect that's still debt that's sitting on the books that's not getting collected until you're able to okay so um if a client isn't paying you know for services or products any bad debt that you incur in the course of running your business is not likely to be deductible okay so the bad debt deduction is going to apply to debt you've acquired as part of a natural business dealing right if you've purchased that from another business you found out that the debt was uncollectible you could write that off right so it's bad that you incur as a consultant or coach or service provider is is not an expense it's really income income that was just never earned so it can't be deducted so be mindful of this when you're watching social media posts or videos and you see folks who want to build up their engagement sometimes they don't always tell the truth so always fact check so unpaid bills um do reduce your overall tax liability because ultimately they're reducing the income or Revenue that's taxable okay so don't seek for deductibility unless you're in the business of buying debt to eventually collect on it it's a no to keep it very very very simple so in the next episode I'm gonna talk a little bit about ways to minimize bad debt ways to make it very easy for your customer to pay you and ways for you to increase your cash collection and your cash management so that you're not putting out Services putting out products before you get paid and you definitely want to retain an attorney to build up the agreements that you need in your course of business I hope you guys have enjoyed this episode let me know your thoughts Below have you learned or heard of something different about how bad debt is handled in a business let me know below see you in the next episode