How is 'bad debt' defined?

The definition of 'bad debt' refers specifically to amounts owed by customers that are deemed unlikely to be collected. This situation arises after a business has extended credit to customers, anticipating that they would receive payment. However, when it becomes clear that the likelihood of receiving payment is very low, those amounts are classified as bad debt. This classification is crucial for financial reporting as it allows a business to recognize potential losses on its accounts receivable and take appropriate measures in managing its finances.

The other options, while they touch on aspects of debts or financial issues, do not accurately capture the standard definition of bad debt. Understanding bad debt is vital for businesses, as it impacts cash flow and the overall financial health of an organization. Properly identifying bad debt allows for more accurate financial forecasting and could influence credit policies going forward.