A big bath is a very large one-time write-off taken by a company. This write-off is structured as a reserve, so that charges taken in the future can be offset against the reserve. The intent behind the use of a big bath is to take a large hit to earnings in the current period, so that future periods will look more profitable. This approach can be valid, but has a reputation for being used too much to manipulate the amount of reported earnings. An investor should be particularly suspicious when a firm has a history of repeatedly taking a big bath, followed by unusually strong earnings in subsequent periods. A big bath is most commonly taken when an organization is already reporting poor results in a year, on the theory that an even larger loss will not bother investors excessively.
A big bath may also be taken when a management team wants to write off assets that have over-inflated or fraudulent values. For example, managers could have created false sales, which require that corresponding accounts receivable also be stated on the books. A big bath can be employed to write off these receivables.
A big bath may also be used when management wants to earn bonuses in future periods. They take a big bath in a losing year, when they will not be earning bonuses anyways, thereby improving the odds that they can earn bonuses in later years, when profits are more likely. This approach tends to result in gyrating earnings from year to year, as big baths are continually taken every few years in order to earn bonuses in the other years.
The big bath approach is more commonly taken by public companies, which are more focused on presenting the most favorable earnings information to investors.