BY FRANK DORIA
Financial executives must continuously balance the cost of doing business with the risk of doing business. Each time a dollar of revenue is produced, all costs of generating that dollar have been thoroughly analyzed in an effort to maximize the profit margin, including costs associated with accounts receivable management.
However, the hundreds of billions of dollars in losses associated with bad debt charge-offs in recent years have brought new attention to managing trade receivables from a risk perspective.
Accounts receivable, which typically represent more than 40 percent of a company’s assets, are naturally a vital component of a healthy business. If a major customer is unable to pay its obligations, or if several customers are unable to pay their invoices, there will be a negative impact to cash flow, earnings, and capital.
In a worst-case scenario, this could literally put a company out of business. These risks require thorough analysis.
Trade credit insurance is a business insurance product that indemnifies a seller against losses from nonpayment of a commercial trade debt. With trade credit insurance in place, the seller/policyholder can be assured that non-disputed accounts receivable will be paid, either by the debtor or the trade credit insurer within the terms and conditions of their policy.
Trade credit insurance is a financial tool which manages both commercial and political risks that are beyond a company’s control. Balance sheet strength is ensured, cash flows are protected, and loan servicing, costs, and asset valuation are enhanced.
A trade credit insurance policy also allows companies to feel secure in extending more credit to current customers, or to pursue new, larger customers that would have otherwise seemed too risky. It significantly reduces the risk of entering new markets.
The protection it provides allows a company to increase sales with existing customers without increasing its exposure. Insured companies can sell on open account terms, where they may be without restricted today, or only sell on a secured basis. For exporters, this can provide a major competitive advantage.
While protecting capital, cash flow, and earnings are what most companies recognize as the main reasons to purchase trade credit insurance, the most common reason to invest in insuring their accounts receivable is because it helps them increase their sales and profits.
The ultimate goal is not simply to indemnify losses incurred from a trade debt default, but to help the business avoid catastrophic losses and grow the business profitably. The key is having the right information to make informed credit decisions and therefore avoid or minimize losses.
A trade credit insurance policy does not replace a company’s credit practices, but rather augments and enhances the job of a credit professional. The best credit insurers will invest heavily in the development of proprietary credit and financial information. Having access to this information allows companies to make more informed decisions about how much credit to extend to which buyers.
More importantly, it enables companies to avoid losses through the close monitoring of their customers.
For more information on how Trade Credit Insurance can help protect and grow your company, please contact me.
Frank Doria is assistant vice president and trade credit specialist for Sterling Risk. He can be reached at firstname.lastname@example.org.