To ensure that losses are limited, risk is mitigated and it's most valuable assets, such as buildings, inventory, employees (human capital), etc. are safeguarded, industry-leading organizations are careful to have an adequate amount of insurance on such assets. Oftentimes, however, a company’s largest and most vulnerable asset, the Accounts Receivable, is left completely unprotected.
The chances of a company’s Buyer(s) experiencing an insolvency or protracted default event are common place in today’s economy and, depending on the size of the loss, could potentially put a supplier out of business unless they are utilizing a risk mitigation tool such as Trade Credit Insurance (also known as Accounts Receivable (A/R) Insurance).
Trade credit insurance provides the following benefits to businesses:
· Protection from unforeseen catastrophic loss such as insolvencies, protracted default, and political risk
· Grows sales by allowing suppliers to offer more aggressive terms, sooner, to existing and new Buyers, without taking on additional risk
· Enhances their current credit department processes
When businesses think of credit insurance they often associate it with one of the above benefits – not realizing it can also serve as a valuable tool in areas regarding their working capital. A key area that may be overlooked pertains to the financing a company is receiving from their bank, factoring company or other asset-based lenders.
Asset-Based lending, where the A/R is used as part of the collateral in the borrowing base by the lender, loans against eligible A/R which is typically only domestic receivables.
Ineligible A/R may consist of concentrations, export A/R, or sales into industries outside of your lender’s comfort zone. For example, if there are concentrations in the domestic receivables, that concentration will typically receive a lower advance rate than the rest of the eligible portfolio is receiving.
With credit insurance, where the lender is generally named as the beneficiary on the policy, what is considered as eligible A/R may expand to include export A/R, sales into “riskier” industries, and increase the advance rate against concentrations. What results is a business which is now able to enhance its borrowing capacity and obtain more favorable financing by utilizing the full potential of what can be a company’s largest asset. In addition, insuring your A/R may also enable you to reduce your bad debt reserves, freeing that money up so it can become working capital.
In speaking with an Asset Based Lender in Southern California, he commented, “Lenders look to credit insurance to mitigate concentration risk. When businesses are growing quickly and continue to increase concentration with a single customer, or within an industry, trade credit insurance can be a great tool in reducing risks to a manageable level and allowing companies to continue growing despite the inherent risk. Another opportunity to utilize credit insurance is during growth cycles where customers are looking to do more international business. Credit insurance is a strategic way to reduce risk and allow companies to grow and expand into new markets.” Bottom line, a trade credit insurance policy will strengthen your company’s balance sheet and provide more security relative to its financial position, despite exposure to unforeseen loss situations, concentrations, and an ever changing global economy.