The Inevitable Reality of Bad Debts in Performance Marketing
For performance marketing agency owners, the focus is rightly on driving growth, client acquisition, and campaign optimisation. However, a less glamorous but critical aspect of financial management is knowing how to handle bad debts. A bad debt occurs when a client fails to pay an invoice that you have already provided services for and have included in your turnover. In the fast-paced, often project-based world of performance marketing, where upfront media spend or significant resource investment is common, a single unpaid invoice can significantly impact cash flow and profitability. Understanding how to handle bad debts isn't just about accounting hygiene; it's a vital tax planning strategy that can recover some of the lost value through legitimate tax deductions, directly affecting your bottom line.
The core principle from a tax perspective is that you can claim tax relief on a bad debt, but only if you have already brought the income into your profit and loss account. This means if you use traditional accruals accounting (which most limited companies do), the unpaid sales invoice has already increased your taxable profit. To correct this, you can claim a deduction for the bad debt, effectively reducing your taxable profit and your corporation tax bill. For the 2024/25 financial year, with the main corporation tax rate at 25% for profits over £250,000, and 19% for profits under £50,000 (with marginal relief in between), this relief is financially meaningful. Knowing how to handle bad debts correctly ensures you aren't paying tax on income you never actually received.
Establishing a Debt as "Bad" for HMRC
You cannot simply write off any late invoice. To claim tax relief, you must demonstrate to HMRC that the debt is genuinely irrecoverable. The key question for agency owners is: when does a debt become "bad" for tax purposes? HMRC requires evidence that you have taken reasonable steps to recover the money. This typically involves a documented process: sending reminder emails and letters, making phone calls, and perhaps issuing a final notice before legal action. If a client has entered liquidation or administration, the debt is clearly bad. If they have ceased trading and disappeared, you can write it off. For persistent non-payers where legal action would be uneconomical (the cost exceeds the debt), you can also make a claim.
It is crucial to maintain a clear audit trail. Document every communication attempt and the commercial decision to write off the debt. This is where modern tax planning software becomes invaluable. A good platform allows you to link supporting documents (email screenshots, final demands) directly to the specific invoice within your records, creating a seamless digital audit trail. This level of organisation is essential not only for your own clarity but for satisfying HMRC should they ever enquire into your tax return. Proactively managing this process is a core part of knowing how to handle bad debts effectively.
The Accounting and Tax Treatment: A Step-by-Step Guide
Let's walk through the practical steps of how to handle bad debts in your accounts and tax return.
Step 1: Review and Decide. Regularly review your aged debtors list. For debts over, say, 120 days old with no payment plan, initiate your formal recovery process. If recovery fails, formally minute the decision to write off the debt in your company records.
Step 2: Make the Accounting Entry. You will create a journal entry to debit your bad debt expense account (an P&L cost) and credit your trade debtors (balance sheet asset). This removes the debt from your balance sheet and records the loss in your profit and loss account.
Step 3: Claim the Tax Deduction. The expense recorded in your P&L flows directly into your corporation tax computation. If your agency made a pre-tax profit of £80,000 and you wrote off a £5,000 bad debt, your taxable profit becomes £75,000. At the 2024/25 small profits rate of 19%, this saves you £950 in corporation tax (£5,000 x 19%). While not recovering the full debt, it provides a crucial cash flow injection.
Step 4: VAT Considerations. If you accounted for VAT on the invoice using standard accruals accounting, you have already paid that VAT over to HMRC. Once a debt is over 6 months old and written off, you can claim a VAT Bad Debt Relief. You adjust your VAT return (Box 4) to reclaim the VAT you paid on that bad sale. For a £5,000 + VAT (£1,000) invoice, you can reclaim that £1,000 from HMRC, a significant recovery. Using a tax calculator integrated with your bookkeeping can automatically flag eligible debts and calculate the precise relief.
Proactive Strategies to Minimise Bad Debts
The best way to handle bad debts is to prevent them where possible. Performance marketing agencies can adopt several proactive measures:
- Clear Payment Terms: State terms (e.g., 14 days) prominently on proposals and invoices. Consider deposits for new clients or upfront payments for media spend.
- Credit Control Process: Implement a strict process: invoice immediately, send reminders at 7, 14, and 30 days overdue. Don't let debts age silently.
- Client Vetting: Conduct basic credit checks on new clients, especially for large retainers or campaigns.
- Stop Work Clauses: Have contractual terms that allow you to pause services if payments are not received.
Integrating these operational checks with your financial dashboard gives you a real-time view of risk. Modern tax planning platforms can sync with your accounting software, highlighting ageing debts and helping you model the tax impact of writing them off. This tax scenario planning allows you to make informed cash flow decisions, such as whether to write off a debt now or pursue it for another quarter.
Leveraging Technology for Bad Debt Management
Manually tracking, documenting, and calculating the tax impact of bad debts is time-consuming and prone to error. This is where a dedicated tax planning platform transforms the process. By connecting to your accounting software, it can automatically flag invoices that are significantly overdue. It can then help you model the specific tax relief, showing the exact corporation tax and VAT savings from writing off a particular debt. This empowers you to make data-driven decisions about when to cease recovery efforts.
Furthermore, such software maintains a centralised, digital record of all write-offs and the supporting evidence, ensuring full HMRC compliance should your return be queried. Instead of scrambling for old emails at year-end, you have a clear, organised history. This systematic approach is the modern answer to how performance marketing agency owners should handle bad debts – efficiently, accurately, and strategically, turning a financial loss into an optimised tax position. For agencies looking to implement this level of financial control, exploring a dedicated tax planning platform is a logical next step.
Conclusion: Turning a Loss into a Strategic Advantage
Bad debts are a cost of doing business, but they don't have to be a blind loss. Understanding how to handle bad debts is a non-negotiable skill for the savvy performance marketing agency owner. By formally writing off irrecoverable debts, you unlock valuable corporation tax relief and potentially reclaim VAT, improving your cash flow position. The key lies in having a robust process for defining, documenting, and accounting for bad debts, supported by proactive credit control. Embracing technology designed for tax optimization removes the administrative burden and provides clarity, ensuring you claim every penny of relief you're entitled to while keeping impeccable records for HMRC. In the end, a strategic approach to bad debt management is a clear sign of a mature, financially astute agency.
