Manufacturers, suppliers, traders, and many more are part of the business-to-business (B2B) system. Companies and industries that belong to the B2B system either provide a product or service to other businesses with payment through credit terms. Trade credit means both companies have agreed that the purchasing client can buy goods (on credit) without paying cash in advance and settle the payment on a decided date(s).
The choice of trade credit is due to the large order and significant payment, which may be challenging to pay in one go. However, allowing clients to pay with trade credit can have advantages and awful disadvantages too.
The advantages are that clients may order more products or services from the supplying business. The biggest disadvantage is there is always a possibility clients may not pay due to bankruptcy, insolvency, or other reasons.
Imagine waiting for millions of dollars and then suddenly finding out the client cannot pay and there is nothing they can do about it. Unfortunately, such risks are common, especially when the economy is down and through a recession. Due to this reason, there is a growing awareness of trade credit insurance.
It is an essential insurance in the current economy and can save businesses millions. The article will explain why some businesses need trade credit insurance and crucial coverage.
What is Trade Credit Insurance?
Even the most trusted clients may suddenly have difficulties in the business income flow, affecting how much and when they can pay their suppliers. Trade credit insurance is a policy that will protect a business from non-payment or significantly late payments due to commercial or political risks.
The insurance will reimburse a percentage of the unpaid amount to allow the business to keep functioning. As these businesses may depend on clients’ payments to invest in manufacturing and selling future orders. Therefore, even a late payment can disturb their workflow.
The insurance will only reimburse a portion of the unpaid amount, typically 75-90 %, but this can differ depending on the exact situation. Additionally, companies can purchase the insurance to cover their entire portfolio or specific accounts.
Many reasons may affect the supplying business and the client’s ability to pay their dues (as discussed in the following section of the article).
What Does Trade Credit Insurance Cover?
Clients order products or services from suppliers hoping to convert them into profit, but this is not always the case. Some companies don’t gain enough profit, which tips over their balance sheet. When a business is insolvent, they are in a sensitive financial state, where they are unable to pay the debts on time.
If insolvency is not dealt with appropriately and quickly, it can lead to filing for bankruptcy. For example, the famous toy brand Toys “R” Us was insolvent for years and eventually declared bankrupt in 2017 after unpaid debts added up to $ 5 billion.
Insolvent companies will not be able to pay the total amount or will propose an extended payment date. (Insolvency can be temporary). Either way, it is tough for companies waiting for their hefty payment.
These situations are unfair to suppliers, manufacturers, traders, or firms that the insolvent company does not pay. Trade credit insurance can protect these companies from financial loss. If that specific account is covered, the insurance will reimburse a large portion of the unpaid amount. The insurance will protect your company so that your business is not impacted by other company’s falls.
Following insolvency, many companies take the bankruptcy route. These businesses have reached a point they have understood and accepted they have no income and debts have gone too high. Bankruptcy is a legal process when a company or individual declares they can no longer pay back debts. Having a bankrupt client is complicated as they may owe you a large amount, which you may never get back.
The legal authority will liquidate the business, and the amount will be distributed to creditors – which is never enough. (Bankruptcy can be permanent). Even the biggest companies can suddenly file for bankruptcy. For example, the huge health supplement brand GNC filed bankruptcy in 2022. In this case, GNC may not have been able to pay its suppliers, manufacturers and more. It is unjust to companies who have already sent the product or provided the service.
Even after liquidation, the fund received (legal authority) commonly does not match the amount due. The only hope to receive a reasonable amount of funds back is with trade credit insurance. As the insurance will investigate the issue and reimburse an appropriate percentage back. Ensure your cover is on accounts that are in financial loss in time, just to be safe.
Some risks are out of business control, such as war, government laws, natural disasters, or economic issues. These are political risks and can affect businesses and their transactions. Any of these factors are out of control for both parties and may pause the flow of funds.
For example, the recent war in Ukraine has affected many businesses internationally. Companies who had already sent goods to the country are now struggling to get back funds. As a result, the government has pleaded with “its international creditors, including Western powers and the world’s largest investment firms, to freeze its debt payments for two years to focus their falling economy”.
In such cases, most companies will try their best to understand but will be negatively impacted, especially the large non-payments. In these cases, trade credit insurance will help international companies by covering a portion of the non-payment due to political risks. These factors can be saddening, but payments are essential for a business to function.
Who Needs to Purchase Trade Credit Insurance?
Trade credit insurance can save some businesses thousands to millions, but not every business needs this insurance. The insurance is designed for any business that sells its products/services to other companies (B2B) with credit-based terms.
Therefore, the insurance will not work for businesses that get the cash before selling, deal with direct customers or low credit based.
Trade credit insurance is perfect for international vendors (wholesalers), manufacturers, suppliers (import and export), and B2B finance sectors. So even if your clients consistently pay on time now – you still need the insurance, as you don’t know what could happen tomorrow. ( The future is always unpredictable)
Businesses purchasing trade credit insurance should understand what may not be covered (exclusions): which are cash transactions, buyers already in financial trouble (before the transaction), intercompany sales and domestic public buyers.
Benefits Of Trade Credit Insurance for Any Company
2023 is forecasted to be a year full of risks that will affect companies worldwide. Hence trade credit insurance is a must and will benefit various businesses. Moreover, the insurance comes with many advantages that can save a company from a large amount of financial loss.
With trade credit insurance, firms providing products or services to other organisations have a safety net. There will always be companies that may not pay or pay too late, which affects a vendor’s balance sheet. Trade credit insurance will protect your balance sheet and help your business move on from unfortunate situations.
As mentioned, even the biggest companies (clients) can be affected by commercial or political risks, stopping them from paying your business. However, just cause a client is financially in trouble doesn’t mean you should be disturbed – and trade credit insurance allows that.
Although you must understand and discuss the process with your insurer, as the amount will not be paid instantly. The insurance company will also assist you to get the payment from the client and then, if all fails, will reimburse you the agreed amount after a period of time.
Therefore purchase trade credit insurance to protect specific accounts or your entire portfolio (no one can be trusted with credit payments!).
To learn more about trade credit insurance and protect your company’s balance sheet and future transactions, contact Red Asia Insurance.