With so much uncertain in today’s economic climate, businesses with significant accounts receivable exposure should consider their credit management options. Trade credit insurance, in particular, offers a strategic advantage for companies looking to shore up bad debt reserves while growing and strengthening business partnerships.
Many businesses buy commercial insurance—including general liability, property, inland marine, cargo, product liability, auto, etc.—to protect secured assets and business income, only to self-insure receivables. For businesses that mostly sell to other businesses, leaving account receivables uninsured means carrying the burden of bad debt reserves; less working capital and more barriers to new business revenue, to name a few.
The IRS reports that bad debt reserves in the US are about 2 percent of annual sales (or $1 million for a business with $50 million in sales). With the recent global impact of Covid-19, it is expected that bad debts could rise to 6 percent or higher.
Financial executives have several credit management strategies to balance sales growth while minimizing bad debt loss, including:
- Letters of Credit: A bank guarantee that the payment of a buyer’s obligation will be received on time, in full. There is security for both buyer and seller, but restrictions in working capital and a tedious single-transaction process limit effectiveness.
- Factoring: An agreement with a third party to purchase accounts receivable at a reduced amount of the face value of the invoices. While offering appealing services such as invoicing and collections, factoring can be expensive and can diminish relationships.
- Assume Risk of Loss: Use of bad debt reserves to offset losses should any customer become unable to pay. Though there is minimal cost to the company in years with few or no losses, the potential for serious, negative financial impact can harm relationships with lenders.
- Trade Credit Insurance. Simply put, trade credit insurance is a business insurance product that protects a seller against losses from nonpayment of a commercial trade debt.
Of these possible solutions, trade credit is the only one that offers a prospective service in the independent evaluation of credit worthiness of a potential customer, and assistance in setting a credit limit while allowing both buyer and seller to maintain a business relationship.
There are other benefits of trade credit insurance, too, such as:
- Business may be able to offer a customer higher credit limits allowing more sales. More sales can yield higher margin which can more than pay for the insurance.
- Business may be able to access new customers and markets.
- Banks may lend more capital.
These direct benefits are key differentiators to other available solutions. There are indirect benefits, too, and these deserve to be underscored. For instance, trade credit insurance works to enhance the business-to-business partnership by leveraging long-term goals and mutual success. If a customer’s credit rating changes over time, the credit insurer can address risks and mitigate losses proactively. And the claims process offers a competitive advantage, too, with shorter, less contentious settlements.
Of all the good reasons to explore trade credit insurance for your business, today’s economic uncertainty adds a sense of urgency. The potential for unpaid invoices is great and growing, whether domestic or international.
Let’s determine if trade credit insurance, or perhaps some other credit management strategy, is right for your business at this point in time. The team and I at Sentinel Risk Advisors are here to help. Call or email me today to get the conversation started.
Jim McCluskey, Partner, Client Executive
Specialties: Complex risk, risk financing, international, mergers and acquisitions