Bad Debts and Health Insurance

Even though we’re smack in the middle of summer, your mind may be on your future to-do list. You can get prepared now by reviewing tips on managing your company’s bad debt allowance and controlling health insurance costs.

Call if you would like to discuss your tax or business questions. If you know someone that can benefit from this newsletter, feel free to send it to them. This month

July 4:
  • Independence Day

In this issue:

  • Bad Debts Cause More Trouble than You Think: How to effectively use your bad debt allowance
  • Ideas to Help Control Health Insurance Costs

Bad Debts Cause More Trouble than You Think

How to effectively use your bad debt allowance

When your business extends credit to customers who don’t settle accounts, their debt becomes bad debt. For businesses using the accrual basis method of accounting, establishing the correct bad debt allowance (also called an allowance for doubtful accounts) can bring the asset section of the balance sheet into focus.

The basics
Binders with paid and unpaid invoices

The bad debt allowance (balance sheet) and related bad debt expense (income statement) accounts were established to help level out the impact of an uncollected invoice on any one particular financial month. By booking a reasonable estimate of bad debt expense each month, the roller coaster ride of writing off an account in any one month no longer materially impacts a business’ income statement. Instead, you build up a bad debt reserve on your company’s balance sheet to account for the actual recognition of writing off uncollectible sales on the balance sheet.

Here’s an example: Assume your accounts receivable totals $500,000. After careful consideration, you determine that only $440,000 is likely collectible this year. By creating a monthly bad debt expense of $5,000 on your income statement, the bad debt allowance on your balance sheet will build up to $60,000 over a year. Then when a write off is required, the reduction is in the allowance account NOT on your income statement. By doing this, you’ll gain a more accurate picture of the company’s monthly financial health, unaffected by one or two large bad debts.

Many businesses use a percentage of prior credit sales to calculate bad debt allowance. If your company’s credit sales totaled $100,000 last quarter and bad debts over the same period amount to 2 percent of sales revenue, you could establish an allowance of $2,000. As an alternative, you might assign risk factors based on individual clients, especially if the firm relies on a few large customers.

Managing your bad debt allowance

Regardless of the method chosen to calculate bad debt allowance, monitoring it should be a priority. Use these guidelines to help you manage your allowance:

  • Understand the tax implications. Only debts that are considered completely worthless and uncollectible can be taken as an expense on your business tax return — the allowance approach described here is not allowed. Some additional analysis and adjustments to the bad debt on your books will be required when it comes to filing your tax return.
  • Diligently track your allowance. Watch for rising and falling allowance levels, as they will help determine your course of action.
    • Allowance is climbing. A bad debt reserve that’s routinely increasing might highlight the need to adjust policies for extending credit or collecting payment. It means your estimate for bad debts is much higher than actual uncollectible debts. Perhaps you are not being aggressive enough in identifying actual bad debts. Lack of attention here could negatively impact your net asset condition and cause unneeded attention from your bank.
    • Allowance is falling. A declining allowance may indicate you are writing off more uncollectible accounts than you estimated. You need to understand the underlying cause. Perhaps a major customer went out of business or your account receivable group is not pursuing collection aggressively enough.
    • Allowance is holding steady. The initial indication here is that your estimate of bad debts might be appropriate. However, you should still conduct periodic reviews of your accounts receivable aging report to ensure your expectations of credit management are being met. Adjustments should be made as the collectability of specific receivables becomes clearer.

Understanding the bad debt allowance and how it works in conjunction with bad debt expense can really help you manage your financial condition and quickly see if your accounts that pay on credit are being managed to your expectation. Call if you have questions.

Ideas to Help Control Health Insurance Costs

As health care costs continue to rise, businesses are facing some tough decisions to stay profitable while maintaining this important employee benefit. With insurance renewal season right around the corner, now is the time to evaluate your plan. Consider these cost-cutting ideas:

Stethescope on bar chart
  1. Review your current plan and shop around. The first step to shoring up your health care benefits is to review your current insurance plan. What do you like about it? Where do you have issues? Engaging your employees and asking for their opinions can provide you some insight, as well. Having a full understanding of your plan allows you to effectively compare the costs of other insurance providers. In many cases you can save costs and add benefits simply by changing insurance companies or coverage options.
  2. Move to a high-deductible health insurance plan. The upfront savings realized by high-deductible health plans (HDHP) make them an enticing option for employers and employees alike. The monthly premiums for HDHPs are lower compared to traditional plans, but the employee has to pay more out of pocket for their health expenses because of the higher deductible. To offset the extra cost to employees, you can offer a health savings account (HSA) to pair with the HDHP. With this approach employees can pay for medical expenses with pre-tax dollars. You, as the employer, can help offset the cost of the higher deductible by making tax-free contributions to your employees’ HSAs.
  3. Consider self-funded options. If properly executed, self-funded insurance plans can save your business money and improve cash flow. The basic concept is that you (the employer) pay the medical claims directly, instead of paying premiums to an insurance provider. Switching to a self-funded plan involves hiring a third party administrator to process the claims, creating a reserve fund to pay the claims, and purchasing stop-loss insurance to protect your company from catastrophic events. All in, a self-funded plan can cut your health benefit costs by up to 10 percent, according to Hub International.
  4. Encourage alternatives to traditional doctor visits. When setting premiums, health insurance companies factor in the cost of covering the claims made by your employees. One way to help control these costs is to educate your employees on the alternatives to traditional clinics and emergency room visits. For example, there are now alternatives such as nursing lines, online doctor consultations and remote monitoring apps that can cut your costs and save your employees some money. With a lower claim history, your future insurance premiums may not be as impacted by skyrocketing health insurance costs.
  5. Promote employee wellness initiatives. Another way to lower medical expenses is to promote the health of your employees. Wellness programs can be as simple as offering flu shots, onsite cancer screenings or organizing a company 5k run. The options are endless, but choosing the correct approach is key to your program’s success. According to a study by Knowable Magazine, an effective program starts at the top. Before rolling out a wellness initiative, present your plan to your company’s leadership team to get them on board.

The proper approach to cutting health care costs is different for every company, so take the time to research your options to ensure the correct fit for your business.

As always, should you have any questions or concerns regarding your tax situation please feel free to call.