Bad Debt Insurance vs Allowance for Doubtful Accounts

What’s the Difference?

Bad debt insurance protects companies when customers fail to pay. Allowance for doubtful accounts (ADA) is an accounting entry that estimates losses from nonpayment.

Both tools address the risk of unpaid receivables—but only one protects actual cash flow.

Why the Comparison Matters

Unpaid invoices put strain on businesses. Companies typically manage this in two ways:

• By booking allowances for doubtful accounts to prepare financial statements.
• By purchasing insurance to transfer nonpayment risk.

The difference is stark. ADA reduces reported earnings but doesn’t provide funds when customers default. Insurance offers indemnity, covering most of the loss and helping companies maintain stability.

Allowance for Doubtful Accounts Explained

The allowance for doubtful accounts is an accounting estimate of how much receivables are unlikely to be collected. It is required under U.S. GAAP and international standards.

• Balance sheet impact: Net accounts receivable is reduced by the ADA balance.
• Income statement impact: Provisions for doubtful accounts reduce reported net income.
• Purpose: Provides transparency to investors, auditors, and lenders.

Under CECL/ASC 326, companies must estimate expected losses earlier and more comprehensively. That has increased the size and visibility of ADA in financial reporting.

But ADA is just a reserve. It doesn’t reduce the underlying business risk.

Bad Debt Insurance Explained

Bad debt insurance—also called trade credit insurance—transfers the risk of nonpayment to an insurer.

• Coverage: Typically 80–90% of eligible receivables.
• Events covered: Customer insolvency, bankruptcy, or protracted default.
• Claims: Insurer pays the policyholder when an invoice goes unpaid due to a covered event.
• Ongoing support: Insurers monitor buyer creditworthiness and alert policyholders to deterioration.

This protection stabilizes working capital, reduces write-offs, and strengthens access to financing.

Side-by-Side Comparison

Why Insurance Offers More Protection

Businesses that rely solely on ADA are left absorbing losses. Bad debt insurance goes further:

• Protects liquidity by reimbursing unpaid invoices.
• Improves earnings by reducing the size of ADA required.
• Enhances financing since lenders accept insured receivables as stronger collateral (see our insurance for lenders overview).
• Provides visibility through insurer monitoring of customer risk.
• Supports expansion by enabling companies to extend credit safely.

Our guide to trade credit insurance explains how this coverage works across industries.

Practical Example

• Company without insurance: Books $2M in ADA for a high-risk buyer. If the customer defaults, the company absorbs the loss and reduces earnings.
• Company with insurance: Books a smaller ADA, knowing coverage will reimburse most losses. If the customer defaults, the insurer pays up to 90% of the $2M receivable. Liquidity is preserved, and financial statements show lower volatility.

FAQs

1. Does insurance replace ADA?
No. Companies still book ADA under accounting rules, but coverage reduces the size of provisions needed.

2. How much protection does insurance provide?
Most policies cover 80–90% of eligible receivables, depending on terms.

3. Why does this matter under CECL/ASC 326?
Because insurers reduce expected credit losses, companies can book smaller ADA balances, improving net income and balance sheet strength.

Summary

Allowance for doubtful accounts records potential losses. Bad debt insurance actually covers them—protecting liquidity, stabilizing earnings, and supporting financing.

Contact us today to learn how we can help protect your business.

Disclaimer:

This blog post is meant to be informative and provide helpful tips and insights into credit insurance policies.  It is not meant to supersede any policy requirements.  Please consult your credit insurance policy for all requirements including claim filing deadlines and required documentation.

Since 2004, Securitas Global Risk Solutions, LLC (“Securitas”) has helped clients develop credit and political risk transfer solutions that provide value on numerous levels. As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring a complete understanding of policy wording and delivering excellent responsive service.