Bad Debt Doesn’t Always Have To Be Lost

The bad debt account and bad debt reserve are among the topics media companies and their employees love to hate. If you set the reserve too low, you may miss budget which is never a good thing. Set the number too high and you are subject to different pressures. In both cases the reserve and what’s actually written off as bad debt can lower incentive compensation and no one wants that.

Bad debt is one of the topics tackled by our experts in the “Special Report on Credit and Collections” included in the current issue of MFM’s member magazine, The Financial Manager (TFM).

Dennis Falletti, senior vice president at the collections firm Brown & Joseph Ltd., begins his article by saying: “In today’s economy and highly regulated business environment, cash is king. And accounts receivable is the next best thing to cash.”

He continues: “It is inevitable that a portion of receivables become past due and some accounts are never recovered. Companies allow for these bad debt losses based on historical and industry recovery trends. This allowance for loss is termed as ‘bad debt reserve’ and it is set aside to cover operating expenses should more than expected bad-debt losses affect cash flow.”

In a related article, Brian J. Harris, a CPA and partner at Miller Kaplan Arase specializing in audits of media companies, outlines the two calculations — a “specific reserve” and a “general reserve” — that factor into a company’s allowance for doubtful accounts.

Harris’ piece is in response to a reader-submitted question about the methodology for determining the allowance for doubtful accounts, including whether it should be done at the local or corporate level.

He explains that the specific reserve is designed to address the balances due from accounts “that the company has determined are not likely to be collected.” General reserves represent an estimate of balances that will not be collected. “This amount is determined even though the company is not aware of any issues from its customers at the time of the calculation. It’s intended to cover the situation in which one or more customers run into difficulties or require billing adjustments and thus do not pay the full amount due on their original invoice.”

While calculating bad debt reserves may seem to be more relevant to the lives of accountants in your organization, there are ramifications to these calculations that can affect commissions and/or incentive compensation for your sales staff (and some management employees). Consider Harris’ comment that since reserving for and/or recording bad debt expense may reduce their potential income, sales staff “may be overly optimistic about the probability of collection.”

At the same time, who better than the employees who have the best knowledge about the customers’ financial situation to determine which accounts should be included in the specific reserve? It is for this reason that Harris recommends specific reserves be set at the local level and general reserves be established at the corporate level. He notes that some companies may take a global approach to this calculation; others may set different percentages by market.

As part of assisting stations with calculating their reserves, MFM compiles separate members’-only DSO (days sales outstanding) reports for radio and TV groups. These reports are available only to members who pay the fee and agree to provide information about their stations. The numbers are not provided to the press or non-subscribers.  If you would like to learn more about these reports, please contact [email protected].

Brown & Joseph’s Falletti weighs in with the next reason for being involved in your company’s bad debt reserves: there may still be money to be made from those accounts that have been written off to bad debt. 

Falletti says the place to start is your company’s litigation threshold, which determines how large an uncollected balance needs to be to warrant legal action. “Since these account balances were too small to sue, it is reasonable to say they have never heard from an attorney, nor felt the impending pressure to pay,” he explains.

He goes on to point out that these businesses are very likely to have made similar decisions about the size of the unpaid account they are willing to litigate in order to recover revenue. “This ‘on the job training’ prepares them for the collection calls they receive,” he believes. “Most debtors know that if they hold out long enough, the collection agency will go away. They are educated enough to know that due to the balance size, they will never hear from an attorney.”

Falletti believes these accounts represent a “sweet spot” for bad debt that includes balances that range from $250 to $9,999.99, or even more. He says, “That span of dollars represents accounts written off as too small to sue and are less than two years from the due date.”

Since sales teams and collection departments may have previously concluded these specific accounts should have been written off as uncollectible, Falletti provides six reasons they may make good on their debt:

• These companies have weathered the financial storm and are still operating.

• Their cash flow has improved.

• The debtor may have a new interest in improving its credit position.

• Hearing from an attorney creates an urgency for payment in order to avoid possible litigation.

• Settlement options are offered to the debtors that cost less than defending the debt in court.

The debtor realizes that this is a legally due debt, and that the money owed will not go away.

He provides the following tips for “going after the honey”:

• Conduct Secretary of State searches to determine if the company has moved, if it is still active, voluntarily dissolved, administratively dissolved or if the debtor is a sole proprietor. The search will help you to determine which companies are still in operation. “After all,” he says, “if they are still in business after a year or so, it is obvious they could have paid, but decided not to do so.”

• Pull credit reports to verify the account in question does in fact have the ability to pay up. Credit searches using resources such as BCCA, a subsidiary of MFM and the media industry’s credit association, can often tell you a lot about the debtor, including whether it is operating out of a new location, if its cash flow has improved, if there have been improper asset sales or if it received judgment reviews. Falletti says, “that kind of information may give you the leverage you need to get them to send you what’s owed.”

• In situations where you have determined the debtor can make a payment, Falletti encourages placing the account with a law office for collection calls. “Since most of the companies that fall into the sweet spot have probably never heard from an attorney, this may help you recover revenue thought lost.”

• He also recommends that you assign these cases on a contingency-fee basis. Approaching it this way, “you will have nothing to lose but revenue to gain,” notes Falletti.

Bad debt is only part of the credit and collection picture. You can read the full text of these articles by Dennis Falletti and Brian Harris along with those from our other credit and collection experts in a complimentary digital copy of TFM which is currently available on MFM’s website. I hope their insights and recommendations give you more to think about the next time the topic of credit comes up in your company.

As its theme of “Unmasking Secrets to Success” suggests, insights for credit, collections and overall business results will also be shared at Media Finance Focus 2013, the 53^rd annual conference for MFM and BCCA, which will be held in New Orleans May 20-22. More information concerning the conference, which serves as the industry’s primary source of professional education for financial and business executives, may be found on our website.

In the meantime, I welcome your thoughts about bad debt and bad debt reserves. Please share your comments here or in a discussion that is underway on the MFM discussion forum on LinkedIn.

Mary M. Collins is president and CEO of the Media Financial Management Association and its BCCA subsidiary. She can be reached at [email protected]. Her column appears inTVNewsCheck every other week. You can read her earlier columns here.