Trade credit insurance policy protects against the risk of customers failing to pay for the goods and services they have received. It provides valuable financial protection in case a sub-contractor or customer defaults, especially for industry sectors dealing with challenging cash flow cycles and payment terms. A trade credit insurance policy is an efficient way of protecting your business against the risk of unpaid receivables for sales done on a credit basis, like export and domestic sales.
How Does It Work?
The insurer effectively buys your bad debt exposure risk in a trade credit insurance policy. If your customer cannot make the payment or goes into insolvency, you can recoup any non-payment losses by claiming your business’s trade credit insurance. The insurer also pays the claim; thus, your cash flow is protected.
The Bankruptcy of A Customer
A customer’s bankruptcy can make a full collection on an invoice virtually impossible. Hence, many organizations opt for trade credit insurance, and it helps them feel more comfortable lending with accounts receivables that are used as collateral.
Foreign Trade Issues
Many issues, like communication and culture issues, unforeseen cancellation of permits, serious global political events, government interventions, expropriation, or currency inconvertibility, can arise in international trade that can prevent or seriously delay payment.
An organization must respond quickly when a business opportunity for increased sales arises. They need the capability to thoroughly and promptly analyze potential customers’ viability and financial stability, or they may risk missing a sales opportunity. A trade credit policy will provide this service by accessing extensive information databases to quickly assess a customer’s viability, including the payment profile, solvency, trading history, risk, and some intangibles. The provider can also monitor critical accounts, eliminating the cost of doing it in-house.
In an average company, the receivables make up to 40% or more of its balance sheet assets; this has a major impact on cash flow and how investors and banks view the company’s financial viability. With trade credit insurance, the company can get better financing terms and a lower interest rate if its receivables are insured. The company can also avoid bad debt losses and reduce or eliminate the bad debt reserve. The loss on a profit and loss statement due to a bad debt can be severe because if the business operates on a low margin and cannot collect the debt, it has to generate much more in top-line sales.
The insurance allows the firm to match its competitor’s credit limit and pay terms quickly.
Business Growth With Confidence
If you want to build and grow your business, buying trade credit insurance would greatly help you. It will allow you to avoid restrictive letters of credit or up-front cash payment requirements and offer competitive, open credit terms in the global market. Hence, firms should opt for a trade credit policy if they are going to expand globally since international trade carries an exponentially larger risk of bad debt, due to which the company may require a wire transfer upfront or a letter of credit, or the potential customers may resist paying in advance, especially if they can buy from another company without these restrictions.
Trade credit insurance helps bridge the traditional gap between the sales department and the credit department, which are often at odds. This can help the company to be organizationally aligned and focused on growing the business. The firm can also streamline the accounts receivables and collections department, focusing on day-to-day issues and leaving the credit monitoring and evaluation to their insurance partner. This insurance policy can also provide a more stable and confident environment for sales and marketing to enter the global market.
So, in short, a trade credit insurance policy can help a company in the following ways:
- Protecting against risks that are out of their control.
- Improving the bottom line quality of the business.
- Increasing profits and reducing risks of unforeseen customer insolvency.
- Letting the company offer credit to new customers.
- Improving funding access at competitive rates.
- Optimizing bank financing by inspiring trade receivables.
- Supplementing credit risk management.
- Protecting from anticipated earnings restatement.
- Maintaining cash flow and profitability.
- Paving the way for better borrowing and financing options.
- Helping to prevent losses before they occur.
- Protecting budgets and business plans.
- Improving credit decisions.
- Reducing and quantifying bad debts.
- Increasing the firm’s profitability.
- Providing a secure path for clients’ information screening.
- Shielding the company’s investors and stakeholders.
- Helping to grow sales with self-assurance.
- Protecting the company’s Income Statement and Balance Sheet against bad debt.
The Bottom Line
For all businesses, it is important that they protect themselves against the potential domino effect of late payments and customer insolvency. Trade credit insurance can help them enter into transactions on credit with greater confidence.