What is a bad debt?

When does a late invoice become a bad debt?

Late is not bad. An invoice is a bad debt when you have concluded, reasonably, that the money is not coming: the customer has entered liquidation or bankruptcy, cannot be traced, or has refused to pay and the amount does not justify court action.

Writing it off does not mean giving up on it. It means the accounts stop treating it as an asset. If the customer later pays, the write-off is reversed and everyone is pleasantly surprised.

The write-off is a cost in the profit and loss, usually on its own line so it is visible. It reduces taxable profit, because the sale was taxed when it was invoiced and it turned out not to be a sale at all.

A worked example

A builder invoices a property developer £3,600 — £3,000 plus £600 VAT — for a job completed in January. The developer goes into liquidation in June with nothing for unsecured creditors.

The builder writes off the debt. Trade debtors fall by £3,600, and a bad debt expense of £3,000 appears in the profit and loss. Profit is reduced by the net amount only, because the £600 was never the builder's money; it was VAT collected on HMRC's behalf.

That £600 was paid over to HMRC on the January quarter's return. Once the debt is more than six months past its due date and written off in the books, the builder reclaims it on the next VAT return as bad debt relief. The total loss is £3,000, not £3,600.

What is the difference between a bad debt and a doubtful debt?

A doubtful debt is one you think may not be paid, but do not yet know. Rather than write it off, the accounts make a provision — a reserve against it — so profit is not overstated while you find out. A bad debt is one you have decided is gone.

Small businesses rarely bother with provisions, and HMRC only allows relief for specific debts you have genuinely assessed, not a general percentage. The practical approach is to chase hard, decide honestly, and write off when the decision is made.