This week, we feature an informative article curated for Nova by Matthew Spann from NCI, experts in trade credit insurance. NCI is dedicated to addressing this pivotal and critical aspect of business protection.
If you have queries, we wholeheartedly endorse Matthew for his unwavering commitment to his clients’ best interests.
How to Protect a Business from Bad Debts
Trade Credit Insurance: An overview
Trade Credit Insurance is protection for businesses against the possibility of non-payment from their customers. Essentially, when trading on credit terms there is a risk that the business they are dealing with will not be able to pay for many reasons but the most common is insolvency. This bad debt that occurs to the businesses can have dramatic impacts such as slowing expansion, hindering cash-flow or even putting the business at risk of collapse. Businesses previously considered “blue chip” have been among some of the most spectacular failures.
The value of a debtors’ ledger is often one of the largest assets on a business’ balance sheet and it is often not insured despite customer insolvency risk being one of the most volatile exposures. A business that works on 5% profit margins and loses $50,000 as the result of non-payment, will have to sell another $1,000,000 worth of goods or services to recoup these costs. Trade Credit Insurance not only protects a business from a situation like this but it gives directors and owners peace of mind that they will be protected – and puts cash back in their pocket therefore making the business more financially stable.
The market for Trade Credit Insurance is wide and varied and is suitable to all businesses who trade on credit terms. Generally, it becomes cost effective when a business has a revenue of more than $2 million per year but there are exceptions and dedicated products tailored for the SME market.
A specialist Trade Credit Insurance broker will assess many aspects of a business before approaching the market. As this process is taking place, the specialist broker will assess different structure types and policy variations will be considered to give the business the best solution based on the most cover, on the best policy structure for the lowest premium. The most common structure is called Whole of Turnover where all insurable sales are covered at 90% indemnity for a 12 month policy period.
- Know who they are trading with by confirming they are dealing with the correct entity
- Have up-to-date terms and conditions that clients agree to
- Have a robust assessment criteria and set a process to evaluate the potential customers and stick to it
- Set specific credit limits and make sure they are justified
What do the Credit Insurers look for when Assessing Risk?
When insurers are assessing a business and their risk, they consider many things but most importantly they will look at:
- Estimated insurable credit sales for the year
- Top exposures and clients
- Three year bad debt history
- Credit procedures
- Industry risk
Benefits of Trade Credit Insurance
A bad debt is really lost net profit and bad debt reserves do not put cash back in their bank account
Protect Liquidity and Cash Flow
Credit insurance policies usually cover 90% of the outstanding debt and claim
payments inject funds back into a business
Confidence to Expand
Having the policy enables growth knowing that the cost of potential failures has already been covered and gives the business a major competitive advantage whilst uninsured suppliers operate with uncertainty. Expanding a business means trading with new customers but also trading at higher levels with existing customers and either avenue involves larger credit risks which this product provides security over should there be a non-payment event.
Strengthen Credit Management
Firm credit limit decisions are provided on the debtors based on sound analysis and
Insuring a debtors’ ledger often provided a new source of security to offer banks who can then be assigned to policies in some cases
Cover for Preferential Payment Demands and Collection/Legal Costs
Most policies include coverage for preferential payment demands for monies received in the six months prior to a liquidation. They also cover collection and legal costs with the logic being that the sooner a business starts third party debt collection the higher the chances of recovery and avoiding or at least reducing a claimable bad debt.
Navigate Away from Bad Debts
In addition to reimbursing businesses for unexpected bad debts, credit insurance also helps businesses avoid bad debts in the first place by helping them steer clear of extremely poor credit risks as opposed to trading blindly. All insurers have a large database which commonly includes confidential information on debtors.
Like insurance for your car or home, Trade Credit Insurance is there for when the unexpected happens. A Trade Credit Insurance policy is there to protect a business against non-payment but it also provides confidence to grow. No one wants to experience a bad debt but for many it is simply part of doing business. A policy’s value is immediately realised when a claim is needed to be lodged and generally, when run properly, a Trade Credit Insurance policy pays for itself with the additional sales and profits generated by having this protection over a customer base. Passing on 90% of the credit risks to specialist Trade Credit Insurers transitions a business from doing risky and unsecured trades to virtually risk-free trades with customers.