A debt is considered bad if there is little or no capacity to pay. A bad debt can be a professional miscalculation (corporate) or ignorance (individual).
In finance, the interest accrued compared to the principal amount borrowed, and the utility derived, gives the valuation of a loan.
Reasons that Turn an Advance into a Bad Investment
1- Loans taken for consumption purposes or paying another debt are prone to degenerating into outstanding payments. Acquiring monies for extravagant activities derives short time pleasures with little or no significant personal development. Payment of such bills is considered a loss.
2- Getting monies from unlicensed dealers who are characterised by high compounded interests with so little time for payments, is regarded as an unworthy venture. Chances of payment are too lean thus the usurer loans bad debt as a way to exploit people.
3- Financial crisis can turn a good overdraft into bad, especially for established firms which transact in dollars or euros. With open economies where the forces of demand and supply determine the price of money, any debt incurred when the markets are stable can be unfortunate when paid during a cash crunch.
Ways to avoid Bad debt / Credit Management
1. Reason for acquisition – have a clear plan on why you need the money. The demand for money should be met with an equal supply, with a significant payback plan: the proceeds from this debt or an alternative source of income.
2. Always acquire debentures from registered and established institutions. They have low interests which are calculated yearly. It gives room for negotiations and enough time for payment.
3. In case of a loss, ensure that the collateral put forth does not generate more than the amount owed. This insulates the debtor from more losses.
4. For businesses, take into consideration the prevailing economic conditions. It helps determine money supply which estimates the price of money, hence makes payment predictable.