A 101 Guide: How to Write Off Unpaid Customer Invoices

Written by on February 3, 2020 in Business with 0 Comments

Unpaid customer invoices can spell major cash flow issues for your business. Having unpaid invoices means that some of your clients were unable to pay for the products or services you rendered. The majority of small business owners struggle with cash flow. Without sufficient funding, entrepreneurs are unable to meet customer demand. Fortunately, small business loans like purchase order financing and invoice financing are readily available.

How Can Unpaid Invoices Affect Your Cash Flow?

Having unpaid invoices means you’ll be paying taxes on the money you haven’t received. Whether it’s a $200 or $20,000, paying taxes on unpaid invoices is money down the drain. For this reason, it’s important to minimize the chances of getting unpaid invoices by implementing the following tips:

  • Perform thorough background checks on all your customers.
  • Make sure your customers understand the term payments.
  • Keep detailed records of transactions.
  • Sign contracts.
  • Send invoices and estimates before you render any service or send products.

But even though you’ve established preventive measures to avoid unpaid invoices, some may still fall through the cracks. With that said, it’s important for entrepreneurs to learn how to write off unpaid invoices. But before anything else, you need to know if your invoices can be written off.

Are You Eligible to Write Off Unpaid Invoices?

If you’re using cash-method accounting, there’s a great chance you won’t be able to write off unpaid invoices. Cash-method accounting only counts revenue when you receive the money; and since you will never receive payment with an unpaid invoice, you won’t be able to write it off.

On the contrary, accrual-based accounting lets you count income when you earn it. But if you know you’re not getting paid for certain invoices, make sure to write it off as bad debt so you won’t have to pay taxes on those invoices.

Do Your Unpaid Invoices Qualify as Bad Business Debt?

Before figuring out how to write off unpaid invoices, you need to determine whether your unpaid invoice falls under the category of a “bad business debt”. There are three things you need to do for the IRS to consider your unpaid invoice as a bad business debt:

  • Prove that your unpaid invoices are worthless;
  • Your business experienced economic loss; and
  • That the unpaid invoices are related to your business.

If you fail to prove any of these to the IRS, they won’t consider your unpaid invoices as bad debt. If this were the case, you wouldn’t be able to write it off.

How Can You Prove That Your Unpaid Invoices are Bad Debt?

The IRS has strict qualifications when it comes to writing off bad debt. This is why it’s important that you have a strong basis that your unpaid invoices can be written off.

  • Worthless Invoices: You need to submit strong evidence that your customer won’t be able to pay you, i.e. death, bankruptcy, etc. In addition, you need to prove that you made an effort to collect the invoice – emails, calls, or SMS.
  • Economic Loss: It’s easy to prove that your business suffered from economic loss if you’re using accrual-based accounting. However, you still need to show proof of the income that turned into “bad debt”.
  • Related to Your Business: To prove that the unpaid invoice is related to your business, you need to demonstrate that your customer was legally obliged to pay you. You can present contracts and other legal documents as proof.

How Can You Write Off Bad Debt?

You can write off useless invoices as you file your taxes. If you found out that an unpaid invoice is worthless and you’ve already paid taxes, you can file an amended return to refund the tax you paid.

How to Bridge Cash Flow Gaps While Waiting for Unpaid Invoices

There are two ways to help you bridge cash flow gaps as you wait for unpaid invoices: invoice financing and/or purchase order financing.

Invoice Financing

Invoice financing helps remedy cash flow issues as you wait on unpaid invoices. Lenders will give you a lump sum upfront in exchange for your unpaid invoices. This allows you to inject money into your business right away. Most lenders will give you up to 90% of the total invoice value while they’ll give you the remaining balance later, minus a small transaction fee.

Purchase Order Financing

If you lack the funding to complete customer orders, purchase order (PO) financing lets you advance funds so you can fulfill customer orders. Similar to invoice financing, purchase order financing funds 80% to 90% of the total supplier cost. The only difference is that the PO financing company will pay your suppliers so you can access the supplies you need to fulfill an order.

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