How good is bad debt? Unearthing Fortune 1000's Losses

No business likes bad debt, but it’s a common occurrence. In this article, we explore the revenue losses companies face when customers fail to pay.

Imagine a thriving business, where sales are surging and customer relationships are strengthening through the flexibility of extended credit.

On paper, everything looks ideal. But beneath the surface, there's a slow, invisible drain: unpaid invoices that, with time, turn into bad debt. 

For many companies, this isn’t just an occasional setback; it’s a recurring cost that grows quietly in the background, eroding profits and eating into cash flow.

As economic pressures mount, CFOs are left with a pressing question: How much is too much? And at what point does a calculated risk become a costly oversight?

Bad Debt: A small leak that sinks big ships

For our analysis, we zeroed in on three powerhouse industries in the U.S.—Manufacturing, Healthcare, and Technology.

Our focus is on the top 50 revenue-generating companies from the Fortune 1000. To truly understand how bad debt chips away at their financial health, we dig deep into two critical metrics:

1. Bad debt-to-sales ratio
2. Bad debt-to-accounts receivable ratio

The bad debt-to-sales ratio reveals the percentage of a company's sales lost due to unpaid invoices, while the bad debt-to-accounts receivable ratio shows what percentage of accounts receivable is considered uncollectible.

Companies in 75th percentile maintain a Bad Debt-to-Sales Ratio of 0.1% or lower

The 2023 Bad Debt-to-Sales Ratio data shows significant disparities among companies:

• High performers (Top 75th percentile) maintained ratios of 0.1% or less
• Low performers (Bottom 25th percentile) had ratios of 0.57% or higher

The average ratio in 2023 was 1.49%, exceeding both high and low performer thresholds. This indicates that while some companies manage bad debt effectively, many grapple with higher ratios, potentially impacting their financial health and operations.

Although these percentages seem small, the actual dollar amounts are significant.

For example, if a company with $1 Billion in sales loses $10 millions in bad debt, that’s 1% in terms of bad debt-to-sales ratio. Reducing the bad debt ratio by another 0.01% could save another $100,000.

Companies in 75th Percentile maintain a Bad Debt-to-Account Receivables Ratio of 0.7% or less

The analysis reveals significant disparities in how companies manage accounts receivables and bad debts.

• High performers (Top 75th percentile) maintained ratios of 0.7% or less.
• Low performers (Bottom 25th percentile) had ratios of 4.32% or higher.

Interestingly, the average ratio across all companies stood at 10.55%, which is considerably higher than both the high and low performer thresholds. This suggests that a subset of companies with extremely high ratios may be skewing the average upward.

Grow fast but not at the cost of bad debt

We uncovered some interesting and potentially concerning trends in the company's financial performance from 2021 to 2023.

Over this three-year period, companies witnessed a Compound Annual Growth Rate (CAGR) of 7.49% in sales revenue, indicating healthy top-line growth. Accounts receivable grew at a slightly lower rate of 6.94%, which is generally positive as it suggests effective collection management relative to sales growth.

However, the most striking figure is the substantial 25.6% CAGR in bad debt. This disproportionate increase in bad debt, compared to the growth in sales and accounts receivable, raises significant concerns about the company's credit management practices and the financial health of its customer base.

These findings prompt us to examine industry-wide data.

Industry-wise analysis of Bad Debt Ratios

Technology: The technology sector boomed during the pandemic, with a year-over-year (YoY) increase of 9.2% in receivables. The overall bad debt-to-sales ratio ranged from 0% to 1.38%. On average, this ratio increased by 0.02 percentage points in 2023 from the 2022 levels. Meanwhile, the bad debt-to-accounts receivable ratio rose by 0.15 percentage points to 2.28% in 2023, up from 2.13% in 2022.

Manufacturing: The manufacturing industry saw an 8.1% YoY increase in accounts receivable over three years. In 2023, the bad debt-to-sales ratio ranged between 0.07% and 1.37%. The industry average rose by 0.03 percentage points from 2022 levels of 0.39%. In the same year, the bad debt-to-accounts receivable ratio increased by 0.13 percentage points compared to the previous year.

Healthcare: The healthcare industry stood out as an outlier, with bad debt-to-sales ratios ranging widely from 0.25% to 55.49%, averaging 5.15% in 2023. The collection moratoriums issued by regulators had forced healthcare & life sciences businesses to temporarily suspend their collections during the pandemic years. This impacted their bad debt expenses and write-offs.

However, this figure has been trending downward; compared to 2022 levels, the ratio decreased by 0.4 percentage points in 2023. A similar trend emerged in the debt-to-accounts receivable ratio—it decreased from 38.13% to 37%, a drop of 1.13 percentage points from 2022 to 2023. 

High Performers' Bad Debt Mitigation Strategies

Here’s what the best performers consistently do to reduce their bad debt:

• Limit Credit Risk Concentration: Leading companies diversify their credit risk and use dashboards to monitor the concentration of accounts receivable (AR) with any single customer or group of customers. They disclose in their financial filings if any customer holds more than 10% of their AR.
• Periodic Credit Risk Assessments: They regularly evaluate customers’ financial conditions using third-party data and credit risk modeling tools—a best practice among companies with low bad debt-to-sales ratios.
• Strong Credit Controls: Many companies require customers to provide letters of credit and bank guarantees to prove their creditworthiness. They ensure that online credit applications are properly submitted before onboarding new customers.
• Credit Risk Prediction and Management: They use real-time credit risk monitoring and robust models to predict customer payments and potential delinquencies. These models incorporate various inputs, including macroeconomic conditions, past payment behavior, and credit ratings, ensuring adherence to the company's credit policy.
• Electronic Workflows: Streamlining customer data collection, approvals, and onboarding through electronic workflows enables accurate data transfer and faster task completion. This approach leads to quicker, better credit decisions while providing a seamless customer experience.

Proactive Collections: In addition to strong credit risk management, most companies have dedicated collection teams to follow up with customers and address grievances. They also offer self-service portals that allow customers to make payments, download invoices, and track credit limits.

The Road Ahead: Taming the Bad Debt Beast

As businesses face higher interest rates and tightening credit conditions, bad debt is poised to become an even bigger challenge. But with the right credit management and collection strategies, companies can minimize its impact.

To stay ahead, businesses should benchmark their bad debt ratios and continuously refine their credit policies. After all, in the game of business, it’s not just about growing fast—it’s about growing smart.