This article explores how trade credit insurance can protect cash flow, strengthens relationships, mitigates risks, enhances competitiveness, and supports expansion amid overdue receivables.
Implementing and effectively managing trade credit exposure plays a pivotal role in stabilizing a company's financial health, by protecting its balance sheet and maintaining its operational efficiency. Organizations are suffering from overdue payments due to high commodity prices and elevated interest rates, putting a strain on customers' ability to pay debts as they fall due, impacting cashflows along the supply chain and the solvency of businesses.
Fluctuating oil prices, geopolitical tensions, and ongoing energy transition, means that the economic outlook may be uncertain for many organizations. A commodity trading company recently faced a significant increase in their expected credit losses, which rose to hundreds of millions, after having low expected credit losses for the last 10 years.
Trade credit insurance covers the risk of business-to-business non-payment, where a supplier contracts with a buyer to purchase goods or services on open account terms.
How can trade credit insurance help
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Protecting cash flow
- Current situation: Organizations may be experiencing a significant increase in overdue receivables, with a high percentage of their receivables more than 60 days overdue.
- Trade credit impact: By extending credit terms, businesses can provide their customers with more flexible payment options but also increase their competitiveness in order to increase sales. This could improve the likelihood of timely payments by reducing the pressure of short payment terms on clients, allowing a longer time frame for the cash conversion cycle, and thereby encouraging them to settle their debts more promptly.
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Strengthening customer relationships
- Current situation: High commodity prices and elevated interest rates may be straining the payment capabilities of an organization's customers, particularly in emerging markets and where there is cross-border export trade.
- Trade credit impact: Offering favorable credit terms can enhance customer loyalty and satisfaction. It demonstrates an organization's understanding of their financial challenges and willingness to support them and be a stakeholder in their business. This can also lead to stronger and longer-term business relationships, with the financial insight a credit underwriter can provide.
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Mitigating credit risk
- Current situation: An organization may be increasing their provisions and expected credit losses from previous levels.
- Trade credit impact: Implementing a well-structured trade credit insurance policy, including thorough credit assessments and tailored credit limits, can help mitigate credit risk. By closely monitoring customer creditworthiness and setting appropriate credit terms, organizations can reduce the likelihood of significant bad debts.
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Enhancing competitive advantage
- Current situation: Multinational companies operate in a competitive market, dealing with numerous customers globally.
- Trade credit impact: Offering attractive credit terms can differentiate an organization from its competitors. Customers facing short-term liquidity issues might prefer to do business with a supplier that offers more flexible payment options, thus attracting and retaining more business.
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Facilitating better financial planning
- Current situation: The increase in overdue receivables suggests potential volatility in an organization's cash flows.
- Trade credit impact: A correctly structured credit policy allows for more predictable cash flow management, as bad debts and lost cash can be effectively replaced. By understanding the payment cycles and behaviors of their customers, an organization can better forecast its financial needs and plan accordingly.
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Supporting market penetration and expansion
- Current situation: Organizations that work with a large number of customers in emerging markets may be particularly affected by high commodity prices and interest rates.
- Trade credit impact: Extending credit terms can be a strategic tool for penetrating new markets and expanding in existing ones. It can lower the initial financial barrier for new customers by removing security normally linked to new markets and making it easier for them to start doing business, thus driving protected growth in diverse markets.
Trade credit insurance can be a powerful tool to navigate fluctuating economic challenges with overdue receivables and credit losses.
Practical steps for implementing trade credit insurance
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Comprehensive credit assessment
Conduct thorough credit evaluations of new and existing customers to assess their ability to meet payment obligations. This can be outsourced to and indemnified by a credit risk underwriter and insurer. -
Tailored credit limits
Set individualized credit limits based on the financial health and payment history of each customer to manage risk effectively. -
Clear credit terms
Define clear and transparent credit terms, including payment deadlines, early payment discounts, and penalties for late payments. -
Continuous monitoring
Implement regular monitoring and review processes to track customer payment behaviors and adjust credit terms as needed. -
Strong collections process
Establish a robust collections process to follow up on overdue payments promptly and consistently. -
Use of credit insurance
Consider using credit insurance to protect against potential losses from non-payment, providing an additional layer of security. This should be tailored to your business and, more importantly, your processes and risk tolerance, and can include the use of an existing captive.
Leveraging trade credit insurance for sustainable growth
Trade credit insurance can be a powerful tool to navigate fluctuating economic challenges with overdue receivables and credit losses. By strategically using trade credit insurance, an organization can enhance cash flow management, strengthen customer relationships, mitigate credit risks, unlock financial insights into buyers, and gain a competitive edge in the market. Implementing a well-structured trade credit insurance policy will not only support an organization's immediate financial stability but also position the company for sustainable growth and resilience in the long term.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.