The business of selling goods and services on credit is exposed to significant risks, many of which are out of the supplier's control. The most significant risk is the failure of a buyer to pay for goods purchased on credit.
Research shows that over 92 percent of businesses that offer trade credit experience late payment of invoices. Nearly half of all accounts receivable (AR) are not paid on time and businesses end up facing cash flow constraints. Therefore, to survive, all businesses must proactively identify and manage their customer credit risks.
Why Manage Credit Risks?
Credit risk management is crucial because late payments devalue the amounts owed. After 30 days past due, accounts receivables are worth about 90 percent of their original value. This amount reduces to 20-60 percent after just 90-120 days from the past due date.
First, there's inflation that reduces the value of money with time. The most significant loss, however, comes from the opportunity cost of your unpaid ARs. With timely payments, you can, depending on your payment terms, trade with the revenue multiple times to make its value exponentially higher after 120 days.
This article provides tips for finding the right lender, managing your AR profile, and making the most of your policy.
PART I: STREAMLINING YOUR ACCOUNTS RECEIVABLE PROFILE
Learn how with these tips:
1. Understand Business Credit Insurance
First, what is trade credit? Trade credit refers to transactions where payment for goods or services is made sometime after receipt. In cash basis trading, buyers must pay for goods before shipping, upon arrival, or receipt of the invoice. For credit trading, buyers have a certain period, typically 30, 60, or 90 days in which to make payments.
Business credit insurance, aka trade credit insurance or AR insurance, is a policy a business takes to protect themselves from AR losses. These losses may come from the various credit risks like buyer insolvency, bankruptcy, currency losses, or prolonged nonpayment, among others.
Trade credit insurance may include political risk insurance, which protects exporters if government actions make the buyer’s debt irredeemable. Such actions include confiscation, war or civil unrest, nationalization, expropriation, embargoes, and sanctions, among others.
2. Reduce Your Accounts Receivable
Most B2C businesses do not offer trade credit terms because tracking individuals is more complicated than for B2B companies. They only offer credit to long-standing customers and even then, for exceptional circumstances only.
In the B2B world, however, the practice is to offer trade credit with payment terms of between 30 and 90 days. Still, you can reduce your exposure by encouraging customers to make prompt or immediate payments.
Most businesses do this by offering a small discount for payment before the collection date or cash payment. For example, 2% off if it’s paid within ten days of receiving the payment invoice. Even though a discount reduces your earnings now, you can reclaim the difference in re-trading as explained earlier.
Such incentives will ensure you don’t have a cash-flow crunch, especially if you trade primarily on credit basis.
3. Include Late Payment Penalties
Accounting professionals suggest that instituting a late payment penalty can incentivize customers to make timely payments. Even if you have business credit insurance, it should only step in to cover the direst cases – your bad debts.
Most businesses charge 2-5% per month on overdue invoices, but you can set up your own terms. Some companies report non-paying or overdue customers after some time, which impacts their customer’s credit score. Many customers will try to pay on time to avoid this because it could limit their ability to access credit in the future.
4. Check Your Customer’s Credit
Not all B2B suppliers subject new customers to a credit check before extending trade credit to them. There’s a cost associated with checking credit, so many businesses avoid it for small accounts. Also, businesses don’t want to pass up clients who don’t have time to wait for their credit status to be verified.
Where possible, however, always check the client's creditworthiness at the beginning of your relationship. A late-paying customer will probably not be delinquent with one vendor; they'll have a history of paying late. If you sell on credit, you can enter a relationship with agencies that facilitate multiple credit checks on a subscription basis or you can order one off reports as needed. More information about credit reporting options can be found on our website.
5. Adjust Your Invoicing Policy
Invoice payment terms explain to customers how your business expects payments. They state:
Accepted forms of payment e.g., no credit cards, cash, or bank transfer only, etc.
Accepted currencies for exporters
Due date and late payment penalties
The due date is the most critical payment term. It should be the shortest possible so that cash flow isn't affected. Today it isn't uncommon for businesses to expect payment within two weeks of invoicing.
Remember, counting starts the day the invoice is delivered, so don’t put off invoicing once goods/services are supplied. Some people send the invoice along with the shipment.
Don’t shy away from reminding customers when payments are due. Send a friendly email or call as the due date approaches and another shortly after the due date. Today’s accounting software suites are capable of sending payment reminders according to a preset schedule.
PART II: FINDING THE RIGHT BUSINESS CREDIT INSURANCE
Trade credit insurance is beneficial to most businesses; however, finding the right insurance partner is critical. Here are tips to help you choose the right insurer:
1. Use a Broker
Business credit insurance policies can be lengthy and hard to understand for people who are not in the field. Plus, a majority of the insurers offering business credit insurance policies only offer their policies through specialty brokers.
Independent brokers can help you find the best combination of flexibility, price, quality, coverage, and products. They typically work with many insurers, which means they have a persuasive muscle that you may not have. Note that “broker” refers to independent brokers and not captive agents who can only promote their employer’s products.
2. Determine Your Risk Management Needs
If you have a handful of credit or export clients, you may need an occasional solution rather than a full policy. In this case, policies can be structured to cover one client or a select number of clients rather than insuring all of your customers. If you have a high volume of local or overseas credit transactions, trade credit insurance may be a big benefit to your business. Premiums are assigned according to the size of the accounts receivable profile, so you’ll only pay according to the amount you need to insure.
3. Think About Pricing
Only after assessing your risk management needs should you consider the cost of AR insurance. Once you have consolidated your AR profile, get quotations from at least five reliable insurers (your broker should manage this for you).
AR insurance pricing is relatively complex because it takes into account the risks of all businesses in your portfolio. For example, if you have many clients coming from an unstable overseas country, expect to pay more. If you’re selling to an established buyer in a stable state, your risks, and hence premiums, will be lower.
Once you have the pricing, weigh it against other methods of protecting your AR to see which gives better value. Bear in mind that quotations may change according to the changes in your AR portfolio.
4. Make the Insurer Your Friend
The second-biggest benefit of business credit insurance is the access you get to risk management capability from the insurer. If you need to research a potential client, your insurer can often help you determine their creditworthiness. If you're thinking about exporting or expanding into global markets, insurers have the resources to assess the viability of your expansion.
In effect, your insurer can act like your risk management partner. You have the same business goal – to ensure as many of your business clients make payments on time and in full.
Multinational insurers have the manpower to assess businesses outside the country. Using their resources, you can ensure you're expanding into a market with a clear but safe sales opportunity.
5. Understand Your Cover
Trade credit insurance protects you from different types of risks. Most policies will cover you in the case of a buyer insolvency or protracted default. However, they may specify the events that qualify as insolvency, often court-ordered liquidations or declarations of bankruptcy.
For exporters, confirm the circumstances that qualify for coverage, considering that trade credit policies differ from country to country. For example, which political risks are you protected from and which ones are not?
6. Understand Coverage Provisions
There are no standard provisions when it comes to trade credit insurance, which means you can customize the policy according to your exact needs. Some policies can cover a single debtor or a specified group of debtors.
Most policies give the insurer the right to subrogation. This means they can try to recover the debt from the buyer after compensating you for nonpayment.
In addition, losses are generally not paid in full; you’ll get a percentage of each debt, e.g., 90%. The balance is the coinsurance or self-insured retention, which is shouldered by the insured party.
Your premiums may also change according to your loss history, among other factors. Premiums that are based on revenue estimates, can change upwards or downwards according to the actual revenue for the insured period. Premiums based on approved credit limits are set up front for the specific limit approval.
7. Limits of Coverage
AR policies usually have a waiting period, which is the period that must elapse from the date of loss before a claim is payable. This period ensures that the seller has made sufficient efforts to recover the debt before making a claim.
Additionally, policies can set different payment terms or credit limits for various buyers. The seller can only extend credit up to this limit, and won’t get compensation for losses beyond the specified limit. The maximum liability limit ensures that sellers do not expose the insurer to high risk, which increases chances of default.
8. Policy Exclusions
All credit policies have specific exclusions, which are AR losses that won't be paid because of the circumstances surrounding the loss. Some standard exclusions include:
Disputes between buyers and the seller – dispute must first be resolved before payment
Shipments to delinquent or insolvent buyers by the time of policy inception
Dishonest actions by the seller/insured party
Any breach of contract by the insured
Late claim filing – reduces chances of debt recovery by the insurer
The omission of pertinent information, e.g., excluding some debtors from the profile
Remember, having insurance doesn’t give you license to act carelessly. For example, if you make a shipment to a buyer who’s already in default on a previous payment, you can’t claim for the second shipment.
9. Who Can Use Trade Credit Insurance
Because trade credit insurance policies are relatively complicated, this insurance is only available for B2B sellers. Contacting your broker is the best way to know whether they have a policy that can work for you. If you come close to matching the minimum thresholds, the insurer may be able to tailor a product for you.
10. Choose a Global Partner
If you trade or intend to trade on the global market, you need an insurer who has a global footprint. Global insurers have the resources to facilitate international credit research. You can benefit from their networks when trying to determine which global markets to target.
Impello Global is a trusted international trade credit and political risk brokerage. We work with all of the major insurance providers to make sure you have access to the best possible solutions. We use our global network to help your business find, structure, and finally implement your global business strategies without increasing your risk exposure.
In the face of the current global slowdown, every business offering open account payment terms should think about getting business credit insurance. For more information and to explore which insurance options may be right for your business, contact us at Impello Global.