Why is it important for companies to estimate bad debt expense?

Estimating bad debt expense is crucial for companies primarily because it helps in predicting future cash flows accurately. When a company makes sales on credit, it does not receive cash immediately. Some of these receivables may ultimately become uncollectible, leading to potential losses. By estimating the bad debt expense, companies can anticipate the amount of receivables that might not be collected, enabling them to adjust their cash flow forecasts accordingly.

This estimation involves analyzing historical data and considering economic conditions that may affect customers' ability to pay. Accurate predictions of future cash flows provide valuable insights into the company's financial health and help in making informed business decisions, such as budgeting, investment strategies, and operational planning. This proactive approach ensures that the company's financial statements reflect a realistic view of its earnings and financial position, ultimately leading to better strategic management.