Expert: Arthur Naman - 3/28/2009

Question
Hi Mr. Naman, I work for a small family business as their controller. I am trying to help the owners understand bad debt to sales ratios, and NSF checks to sales ratios.
Foe Example:  On gross sales of $2.7 mil on a recent entertainment event, we have had 12 checks returned NSF which total $11,000.00. Although some may turn into bad debt, most will be made good on. ( The customer can not purchase the next event unless they have paid up). I am trying to convince the owners of the business that they are in a very good position, and that they are overly concerned with the NSF checks - I want to explain how spending too much time on these NSF is not productive for the company.  We have a procedure in place for collecting NSF. Their time and energy ( and their human resorces) would be better spent in other ways.  How can I persuade them? What ratios and statistics can I use in a presentation? What do you think is a favorable bad-debt to sales ratio %, and NSF to sales ratio %.  Thank you, I am very interested to hear your answer and opinion. Pat.

Answer
Let's begin by considering the company's history. I presume you have historical data to calculate NSF/Bad debts as a percentage of sales or maybe as a percentage of sales paid for by check. I do not know what an industry average is for that ratio -- bad debts to sales. I expect that a ratio of around 0.5% - 2.5% is normal for large companies, from a brief review of a web search on "bad debt ratio." The ratio you described is trivial, as you know. Perhaps you might present some info from the internet on average bad dept ratios, for your industry if available. $11,000 / $2.7 million = 0.41% and that is not taking into account the fact that you are likely to receive payment on most of the bad checks.

Next, how much is the total bad debt write off for (1) a year (2) a month and (3) per event. Now consider the cost of your's (and other employees') time spent in bad debt recovery. You might take each employee's average hourly rate (the normal rate if paid hourly or the annual salary / 2,000); then take that rate and come up with a "billing" rate. By that I mean what would a service company charge per hour for each employee's time. In the accounting world, it used to be the billing rate was 3 times the hourly pay rate. Now I think the multiple is more like 4. That multiple should be enough to cover direct pay costs, indirect costs like payroll taxes, fringe benefits, and an overhead cost for the cost of the space allocated to that individual. Next try to estimate the time spent on bad debt recovery. And finally the cost of time spent on bad debt recovery.

My point being that there is a point where employee time spent on efforts directly involved with earning revenue for the company brings in more revenue than the revenue lost by working on bad debts.

Small businesses, particularly family owned businesses, tend to feel a personal affront from a bad debt. Someone has stolen from them. I am not sure how to present this, but they should not take it personally -- it's just businesses.  People who have bad dept problems tend to not have a specific intent of harming someone, it's just that they have financial problems

If you have additional questions, please ask a follow-up.  I hope this helps.