What is trade credit in business?
When business is booming, and the cash flow is high, the good times really can roll. Unfortunately, the risk of debtor insolvency has become an inherent part of owning a business. In reality sometimes your customers simply fail to pay or perhaps cannot pay you—it happens, but it needn’t be disastrous. In order to keep your business on track it’s worth considering purchasing trade credit insurance.
However you refer to it; trade credit insurance /credit risk insurance, it can ensure your business is protected against customers who fail to pay their debts or substantial delays in receiving payments. Without this type of cover, or a very substantial rainy day fund in place, businesses could find themselves in trouble.
Here are a few facts about trade credit insurance and how it can help you stay in the black:
What is trade credit insurance and how does it work?
Bad debt can be crippling. And in the wake of globalisation, a business’ supply chain and customer base expands beyond national borders. This can mean that debtors and creditors become even further apart. Now more than ever, it is easy to lose track of your customers as well as creating obstacles for their payments, such as government restrictions or political instability abroad. Trade credit insurance can help protect against the various risks of trading across borders.
In the event of non-payment from a client, a policy will typically cover about 90 per cent of outstanding debts. This can ensure that even if there is a payment failure of one large customer or multiple small ones, your organisation remains financially stable.
Trade credit insurance coverage
- Whole turnover covers your company’s entire book of debtors, providing the maximum level of protection against bad debt.
- Specific account applies only to those accounts you feel are at risk. These policies may be subject to an increased premium, and are riskier than whole turnover cover. The gamble you take is that you may select the wrong company to insure against.
Common trade credit insurance policy extensions
Trade credit insurance policies are most effective when tailored to your business and list of debtors. Extensions to policies can help provide that extra layer of protection, typically they include:
- Pre-delivery work in progress, which safeguards against any financial losses due to a customer becoming insolvent before work has been complete. But, after you have incurred costs such as material or labour. If a project goes bust, then your business will not be left to shoulder the debt and pick up the pieces.
- Supplier default, which protects against financial losses from a supplier going out of business. This includes the costs associated with finding new suppliers, the loss of advance payments to the defunct supplier and any possible fines or damages for late delivery.
Depending on which cover you choose, you can arrange a policy for a fixed period of 12 months or for the duration of a specific customer’s contract.
Tailored trade credit insurance
Trade credit insurance is a small, specialised field and therefore requires careful risk assessment. An effective trade credit insurance policy will keep you above water when your customers go under. An ‘off the shelf’ policy might not suffice; ensure it’s correctly customised for you by your broker, who can advise you of what is needed.
Source: Zywave Cover Overview: Trade Credit Insurance