Bad debt is debt that is issued which the creditor is unlikely to collect. This results in the debt either having to be written off or sold (or a combination of the two).
Debt becomes bad when all reasonable efforts were made by the creditor to collect on the money owed. Due to a variety of circumstances, the creditor is unable to obtain what is outstanding.
The debtor often files for bankruptcy, resulting in debt going bad. Depending upon what other liabilities are outstanding, the creditor might not be able to recoup much of anything.
This state also arises when the money collected might cost more than what is outstanding. For this reason, debt is often sold to collection agencies at a reduced cost, salvaging some money.
When a business writes off the debt, it is shows as an expense on the income statement. This results in a reduction in the taxes owed based upon income. It also negates the cashflow the company would have received as a result of the payments being made.
