When businesses fail to pay a commercial debt, there is a fallback called credit insurance coverage that is designed to protect the business. Credit insurance coverage ensures that invoices are paid. It helps companies better manage certain risks of trade that may be outside their control. These risks can be commercial and political. Insurance coverage ensures:
- Protection of capital
- Maintenance of cash flow
- Enhancement of loan servicing and repayments
- Security of earnings
On paper, commercial credit insurance coverage might sound like the smartest investment a business can make, however, it is important to note that the coverage is designed for only B2B accounts. It is not ideal for businesses that are consumer-oriented or that sell exclusively to the government.
The trade credit insurance coverage acts as a safety net. It helps businesses pursue riskier accounts. When they have the protection of insurance coverage, they can extend credit to existing customers. They can even go after new and larger customers, which would have otherwise been deemed risky, if not for the credit insurance. The protection allows companies to grow their businesses through existing customers. Companies that have been insured can conduct sales on an open account, where previously, they may have been restricted or only allowed selling on a secured basis. The trade credit insurance coverage is highly advantageous for exporters.
Now that we know what trade credit insurance is, let us look at what it is not. While it is a great security blanket, it certainly is no substitute for well-planned and thought-out credit management. For any credit insurance policy to be deemed useful, it must be backed by sound credit management practices. The purpose behind trade credit insurance coverage is to enhance the job of credit professionals and not to entirely replace the existing credit practices of a business.
The advantages of trade credit insurance coverage
By now we have affirmed that trade credit insurance can be a practical tool for businesses that wish to enter new markets, build on customer loyalty, and chase down new targets. However, it also has a flipside. Trade credit insurance coverage can put pressure on your cash flow and working capital. For an effective cash flow management strategy, trade credit insurance helps you to control credit risk.
The primary advantage of trade credit insurance is that, in case of a result of bad debt, your business will be compensated fairly quickly. Therefore, it would help stimulate your working capital ratio and reduce the uncertainty surrounding cash inflow.
Additional benefits of trade credit insurance:
- Improves the Day Sales Outstanding. The Day Sales Outstanding or DSO is the average number of days required to recover a payment post-sale.
- Gives the guarantee to a business to manage operations and investments in the short term. This in turn helps secure the growth of your business.
- Assures your financial partners, bankers, and shareholders that your business is financially stable. This also helps them give you more financial backing, thus ensuring a flow of capital.
- Helps you implement a robust trade credit strategy that can help push your business to new heights. While you seek growth, insurance coverage protects you from the risks of cash flow from trade credit.
Companies often invest in trade credit insurance for:
- Expanding sales: A company can pursue customers that may have been deemed too risky and even sell more to their existing customers. This is possible due to the insurance of the receivable.
- Entering new territory: This insurance can help you venture into foreign markets as it helps mitigate risk and gives your market knowledge that is essential to make better decisions.
- Improved financial terms: If a company has insurance against receivables, banks are always willing to lend more and even reduce funding costs.
- Bad-debt reserve reduction: The insurance of receivables allows a company to free up capital. This is in part due to the insurance premium being tax-deductible, while the bad reserves are not.
- Economic knowledge: The insurer has a useful informational database along with a technology platform that can alleviate the operational and informational costs.
- Averting disaster: Nobody can predict the future and should there be a disaster that cannot be mitigated, the bill will get paid via the claims process.
- Sales and profits increment: One of the biggest advantages of a credit insurance policy is the ability to offset its own cost multiple times. The policyholder is not required to make a claim to do so and can also additionally increase the sales and profit of the company, with almost zero risks.
- Improving the relationship with a lender: Trade credit insurance allows companies to improve their relationship with a lender. Often the bank approves asset-based loans only if there is trade credit insurance.