What is bad debt expense?

Bad debt expense represents the cost of accounts receivable that become uncollectible and is recorded as an expense on the income statement. For consulting firms, bad debt typically runs 1-3% of revenue with well-managed clients, but can spike significantly when credit practices are poor. This expense directly reduces profitability and often exceeds the profit margin on the lost project, making client credit management essential.

Key characteristics

• Recorded when specific accounts are deemed uncollectible

• Also estimated using the allowance method based on historical rates

• Target: under 2% of revenue for consulting firms

• Tax-deductible when properly documented and written off

• Analyzed by client type, project size, and payment terms

• Leading indicator for client credit quality issues

Why it matters for service firms

Bad debt expense directly erodes profitability and represents work completed but never compensated. A consulting firm with 25% net margin loses the entire profit plus 75% of costs when a project becomes uncollectible. A $50,000 project written off to bad debt requires $200,000 in new revenue to recover the lost profit. Prevention through credit checks, upfront payments, and milestone billing is far more effective than collection efforts after the fact.

Real-world example

Vantage Consulting writes off $42,000 in bad debt due to a client's bankruptcy, its most significant loss ever. The $42,000 represented a 4-month project with $31,500 in direct costs (consultant time) already incurred. At a 22% net margin, the firm would have made a profit of $9,240 on the project. Instead, they lost $31,500 plus opportunity cost. To recover, the firm needs approximately $190,000 in additional revenue. The founder requires credit checks for engagements over $20,000 and 30% upfront payment for new clients. Over the next two years, bad debt expense drops from 2.8% of revenue to 0.9%, saving approximately $35,000 annually.