Unpaid invoices are an unavoidable reality for many Australian businesses. Whether you’re running a small family-owned company or managing a fast-growing enterprise, the challenge of chasing overdue accounts can quickly impact your cash flow—and, ultimately, your bottom line. In 2025, with ongoing economic uncertainty and evolving ATO guidance, understanding and effectively managing your allowance for bad debt has never been more important.
What is Allowance for Bad Debt?
The allowance for bad debt (sometimes called the provision for doubtful debts) is an accounting method that anticipates potential losses from customers who are unlikely to pay their outstanding debts. Rather than waiting until an account is officially written off, businesses estimate and record expected losses in advance. This approach provides a more accurate reflection of your business’s true financial health and ensures compliance with Australian Accounting Standards (AASB 9 and 136).
- Example: A wholesaler has $200,000 in accounts receivable at 30 June 2025. Based on historical data and current economic conditions, they estimate that $8,000 may never be collected. The $8,000 is recorded as an allowance for bad debt, reducing the net accounts receivable on the balance sheet.
Why the Allowance for Bad Debt Matters in 2025
Economic headwinds and rising insolvencies in 2024 and early 2025 have led many Australian businesses to scrutinise their credit policies and risk management. The ATO has also updated guidance on claiming bad debt deductions, with closer attention on substantiating your estimates and demonstrating genuine efforts to recover debts. Here’s why the allowance for bad debt is critical right now:
- Financial transparency: It ensures your reported profits aren’t inflated by receivables that may never convert into cash.
- Tax compliance: The ATO allows businesses to claim a tax deduction for bad debts written off, provided you can show the debt is genuinely unrecoverable and was previously included in assessable income.
- Risk management: A realistic allowance helps businesses prepare for cash shortfalls and maintain liquidity in uncertain times.
In 2025, with tighter lending standards and higher interest rates, banks and investors are scrutinising the quality of receivables on balance sheets more closely than ever. An accurate allowance for bad debt signals sound financial management and improves your credibility with lenders.
How to Estimate and Manage Your Allowance for Bad Debt
Setting the right allowance isn’t guesswork. It’s a data-driven process that combines historical trends, current economic insights, and real-time customer assessments. Here’s how to get it right in 2025:
- Analyse past data: Review your business’s history of bad debts over several years. What percentage of receivables typically goes unpaid?
- Segment your customers: Identify high-risk customers or industries. In 2025, sectors like construction and hospitality are experiencing higher default rates according to ASIC insolvency statistics.
- Factor in current conditions: Consider economic shifts, interest rates, and any recent events affecting your client base. The ongoing cost-of-living squeeze has impacted payment cycles for many SMEs.
- Use the ageing method: Break down your receivables by how overdue they are. For example, debts 90+ days overdue may warrant a higher provision than those just past due.
- Document your rationale: The ATO requires businesses to keep clear records justifying their bad debt estimates and demonstrating recovery efforts. A robust paper trail can protect you during audits.
Example calculation for 2025:
- Receivables not yet due: $100,000 (1% allowance = $1,000)
- 1–30 days overdue: $40,000 (3% allowance = $1,200)
- 31–90 days overdue: $30,000 (10% allowance = $3,000)
- Over 90 days overdue: $30,000 (20% allowance = $6,000)
Total allowance for bad debt = $11,200
Best Practices for 2025 and Beyond
- Regularly review your allowance: Update your estimates at least quarterly, or whenever there’s a significant economic event or change in your customer base.
- Integrate credit checks: Use up-to-date credit data and monitoring tools to flag at-risk customers before debts become uncollectable.
- Actively pursue overdue debts: The ATO expects to see evidence of collection efforts, such as reminder letters, phone calls, and legal action if warranted.
- Consult with your accountant: Ensure your allowance methodology aligns with current accounting standards and ATO requirements for 2025.
Adopting these practices not only strengthens your financial reporting but also positions your business for resilience in an unpredictable market.
Conclusion: Turn Uncertainty into Confidence
While unpaid invoices will always be a challenge, proactively managing your allowance for bad debt is a powerful tool for business owners in 2025. It reflects prudent financial management, supports tax compliance, and helps you navigate periods of economic uncertainty with greater confidence.
