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Trade credit insurance (TCI), also known as accounts receivable insurance, debtor insurance, or export credit insurance, is a business insurance that compensates organisations if their customers fail to pay for supplied products or services. Non-payment may be because of bankruptcy, insolvency, or political upheaval in the countries where the trading partner operates. TCI can help businesses to protect their capital, stabilise their cash flow and support them to secure better financing terms from banks, as lenders can be sure their client’s outstanding invoices will be paid under any circumstances.
Trade credit insurance is designed to mitigate the risk of non-payment by a company’s customers. To establish a trade credit insurance policy, insurers will scrutinise the volume of trades a client engages in, the credit risk of its buyers, the industry in which it operates, and the repayment terms to which their buyers have agreed. As you may expect, the higher the risk of non-payment, the higher the cost of the policy, although typically, coverage will cost less than 1% of the insured sales volume. Most trade credit insurance policies will cover payments for products and services that are due within 12 months.
Businesses can tailor their insurance coverage to fit their budget and will usually have the option to cover all or some of their clients. They may also choose to insure only one customer —especially if it’s a large or particularly risky account. Based on the financial strength of a client’s insured trade partners, insurers will typically assign each customer a set credit limit. Should a customer fail to pay for delivered goods or services, the insurer will only cover losses up to the pre-agreed ceiling.
Trade credit insurance is essential for:
Trade credit insurance cover falls into two main categories:
Trade credit insurance can provide multiple benefits to insured businesses:
Protect against non-payment: Should a customer be unable to pay its debts due to insolvency or protracted default, trade credit insurance will pay out a percentage of the outstanding amount owed (typically around 90%).
Boost sales growth: Because they know they will be reimbursed if their customers do not pay their debts, businesses can safely sell more to existing customers or expand to attract new customers – actions that may have previously been deemed too risky.
Expand into new international markets: TCI can protect businesses from the risks of exporting overseas.
No two trade credit policies cost the same. The premiums for your trade credit insurance will depend on your type of business, the value of your sales, the scale and creditworthiness of your customers, the level of risk attached to the territories where you sell, the amount of cover you choose and the limit of your policy excess.
You should obtain commercial property insurance as soon as you exchange purchase contracts on the property. Unseen events that damage or destroy the property can occur at any time, so it is recommended that you get cover immediately and do not wait until you physically occupy the building or start trading from the premises.
Top tip: If you do not intend to occupy the building within 30 days of taking out your insurance, you must tell your insurer.
Businesses can choose other methods to protect themselves from non-payment by their customers.
When businesses self-insure, they create a reserve fund to cover losses from unpaid accounts. Although there are no premiums to pay, the downside to this strategy is that a company may have to set aside a large amount of working capital for loss prevention instead of using that money elsewhere to grow the business.
Companies can also sell their account receivables to a third party known as a factor. This is a lender who buys your outstanding invoices and then attempts to collect the receivables itself. A factor will typically purchase your account receivables at a discount—usually paying you 70% to 90% of the invoiced amount – although you can receive the funds within a few days of issuing the bill instead of waiting weeks or months for your buyer to pay.
You may receive a larger percentage of the invoice value if the factor manages to collect the full debt, but you will still have to pay a substantial fee for the factor’s services. Additionally, should the factor fail to recover any or not enough of the debt within a set timeframe – typically 90 days – they may reject the invoice and claw back the money they have paid you in advance.
Note: An alternative to factoring is invoice financing. This works much like factoring, but you remain responsible for chasing your buyers for payment, not the lender. The main advantage of this system is that you keep control of your sales ledger, and your customers need never know you are borrowing against their debts.
Companies that trade overseas could obtain a letter of credit from their buyer. This is a guarantee from the buyer’s bank that you will be paid in full by a specific date. However, letters of credit can only be obtained and paid for by the buyer, and they may be reluctant to pay a transaction fee of anywhere between 0.75% and 2% of the invoice value to obtain the bank’s guarantee. Additionally, a letter of credit will only pertain to a single buyer, putting the onus on you to protect your other receivables.
All business involves risk, but that doesn’t mean you have to suffer the consequences if things go wrong. Don’t let unpaid invoices become a burden on your business. Contact Swoop today to compare top-quality trade credit insurance policies and to discuss all your business insurance needs.
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