Allowance For Credit Losses

When a financial institution, like a credit card issuer or a bank, lends money, they hope all the funds get paid back. However, they know this doesn't always happen. And while it may be impossible to predict which of today's well-meaning borrowers will turn out to be tomorrow's unrepentant deadbeats, the lender can guess with some accuracy what percent of their total accounts will go south.

To counteract these bad loans, the companies set aside an estimated percentage of revenues for deadbeats. That number sits on their balance sheet, adjusted quarterly. The amount is known as the "allowance for credit losses."

Rather than being shocked and appalled each time someone fails to repay a loan, the bankers assume some of the money will become vapor. Using past experience, industry and regulatory guidelines, and some high-class math, companies arrive at a reasonable estimate of the likely losses and bake this figure into their balance sheet.