Meaning
Protection policies that indemnify a business against the risk of non payment by its customers secure the accounts receivable of a firm. This trade credit insurance covers losses caused by buyer insolvency, bankruptcy or protracted default. It allows a manufacturer to offer more generous payment terms to its clients while protecting its own cash flow.
The policy usually covers a specific percentage of the total debt, with the insurer taking over the collection process after a claim is filed.
Default Indemnity
Recovery of lost funds from an unpaid invoice ensures that a single bad customer does not cause the financial collapse of the supplier. Trade credit insurance is particularly valuable for exporters who may have difficulty navigating the legal systems of foreign countries. The insurer uses its vast database to assess the creditworthiness of the buyers before the sale is even made.
This external vetting process helps the sales team focus on customers who are likely to pay.
Liquidity Shield
Banks are often more willing to lend against insured receivables, which increases the company’s total borrowing capacity. By using trade credit insurance, a firm can effectively convert its risky customer debt into a high quality asset. This is a common strategy for companies in low margin industries where a single large default could erase a year of profit.
The cost of the premium is treated as a necessary expense for protecting the balance sheet.
Premium Cost
Rates for the coverage depend on the industry, the historical loss record of the company and the credit ratings of its customers. Managing trade credit insurance involves constant reporting of new sales and notification of any payments that are even a few days late. Failure to follow the insurer’s strict reporting rules can result in a claim being denied.
The discipline required to maintain the policy often improves the internal credit management processes of the whole company.
