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Preparing for Rising Business Failures with a Recession Looming

It's been an unprecedented couple of years. You know how much your business has changed, but do you have any idea how much your customers’ businesses might have changed? The looming threat of recession, increased cost of capital, inflation, and the strong dollar are gathering momentum to brew the perfect storm that experts predict will yield an increase in bankruptcies. In fact, commercial bankruptcies have recently begun trending upward.

Customer defaults can be devastating for SMEs, especially if they cause a substantial bad debt loss. This is money you expended on the customer’s behalf, which now cannot be recovered except through new sales that are many multiples more than the loss, depending on your profitability percentage. A large volume of bad debts can even render a SME insolvent. At lower levels, bad debt losses may still require you to borrow funds with restrictive loan covenants, give up some or all control of the firm, and so forth. Or, you may be forced to cut costs dramatically, damaging your firm’s ability to serve customers — this is especially true when you must lay off key workers, who may be difficult to rehire if and when your business recovers.

Protracted defaults, which are late payments from customers - create cash flow shortages which may force you to lean on financing for working capital, and invest a significant amount of time to accelerate that late payment. Even when you do eventually get paid, you never recover the time or the worry you expended chasing what was owed to you, let alone recover the actual cost of collection fees and borrowing. Worse, even vigorous efforts do not guarantee that you'll get paid.

What is the solution for SMEs? One holistic solution involves transferring the risk and responsibility of Accounts Receivable (AR) management to a trade credit insurance carrier. An investment in trade credit insurance will save your company the time and associated expenses necessary to successfully manage your AR without burdening your staff while ensuring cash in-flows and eradicating bad debt losses.

Think of Trade Credit Insurance as a Service People often look at credit insurance as just another expense. In fact, there can be considerable offsets against this cost. Besides offsetting your annual bad debt losses, the cost of credit bureau reports, as well as collection agency or attorney fees, there are operational advantages when you evaluate the impact of credit insurance from a service perspective. Here are three points to consider:

1. Let the carrier assess credit risk and monitor customers for signs of a weakening financial condition: Identifying customers at risk of default is relatively easy for publicly held companies, which are required to disclose huge amounts of financial data every quarter. It's a relatively simple matter to determine if they have the working capital and cash flow to pay your invoices at the present time or not, and assuming they can, if there will be a time in the future when payment could become problematic. Because these are often large accounts, it's prudent to review their financials quarterly.

The assessment of financial strength and liquidity is more difficult for privately held customers. They are unlikely to provide financial statements unless they require a substantial credit limit. Therefore, you need to always be on the lookout for signs of financial distress, especially in our current economic environment. See Red Flags a Private Firm Is in Distress: Be Prepared for Rising Business Failures with a Recession Looming, by John G Salek and David Schmidt for more details.

Typical monitoring for privately held buyers may include, at minimum, annually ordering/reviewing a credit report, securing bank/trade references or possibly comparing notes on customer payment experience with members of your business association. Large corporations have entire credit management teams handling the responsibility of monitoring their customers. It takes time and expertise. For SMEs, this is a daunting task and perhaps, best transferred to an insurance carrier. Underwriters are experts in determining creditworthiness so you don’t have to be!

2. Allow the carrier to lead the collection effort: Collection fees are expensive and erode your profit margin. Some trade credit Insurance carriers give their policyholders access to collection services at reduced rates. In fact, Atradius policyholders enjoy zero collection fees for insured accounts and Coface only charges 4.5 percent. Collection Agencies, in comparison, typically charge 25% to 33% on a contingency basis. If the insurer’s collection efforts are not successful, no worries - the policy is triggered and you will be made whole with a claim payment.

3. Get some leverage: Many trade credit insurance policies require that you hold orders if there is a significant past due balance, permitting insured future shipments only when the account is current. This means your credit holds are non-negotiable. The message to your customer is that credit limits and past due policies are set by your insurer and cannot be violated, so what can be done to get this past due cleared up and the new order shipped?

Do you sometimes feel like your demands for on time payments are muted by the fact that you’re a SME? An in force trade credit insurance policy can help with that. Carriers insure buyers (you call them customers, carriers call them buyers) for many different suppliers and your customers know this. Furthermore, your customers know that significantly late payments can mean cancellation of coverage for future shipments, not only from you, but also from other insured suppliers.

Your trade credit insurance policy can also help you get a higher credit limit and better interest rate if you have an Asset Backed Loan (ABL) that includes your AR as collateral. This is simply because there is less risk for the bank. Having credit insurance in place can result in your lender increasing the amount that can be borrowed against your AR by 5 or 10 percent (or even more) besides knocking a significant percentage off the interest rate. What about Pricing? Remembering the 2008 Great Recession, some trade credit insurance carriers in a knee jerk reaction were quick to cancel coverage at the beginning of the COVID crisis, protecting themselves in anticipation of a deluge of bankruptcies. But contrary to expectations, the crisis did not force all marginally performing businesses into bankruptcy. In fact, bankruptcies decreased owing in large part to government lending initiatives such as the Paycheck Protection Program (PPP).

Source: Statistics from Epiq on the American Bankruptcy Institute website

The evaporation of coverage and lack of defaults resulted in relatively low demand for trade credit insurance. As a result, companies now seeking quotes should find robust coverage for most industries along with fair rates. If you've explored quotes in the past, you may find the carrier now offering better coverage, more favorable terms and more competitive rates, making a trade credit insurance policy an attractive value proposition. Minimum premiums remain the same — $10,000 for domestic coverage. ExIm remains a great choice for SMEs that export, with typically only a $500 deposit necessary to bind coverage. The Bottom Line… Identifying struggling privately held buyers is time consuming and not always achievable. Monitoring publicly held companies can be onerous. Collection problems with either class of customer can put a tremendous burden on your staff resources.

A trade credit insurance policy allows an SME policyholder to outsource the responsibility for determining the creditworthiness of their customers. It's possible that even when claim-free, the cost of the policy can be absorbed in reduced time spent performing credit and collection tasks, and the associated expenses (credit reports, collection agency fees).

Finally, a trade credit insurance policy may give you some leverage to get paid on time, while at the same time, liberate you from worrying that you won’t.

If I can help with a no cost, no obligation quote presentation, please click the button below to access my calendar. Now is the time to prepare for the tough times ahead. At the very least, you'll have an analysis of the creditworthiness of your buyers.

This post is a collaborative effort with David Schmidt at YVCM. Your Virtual Credit Manager (YVCM) is ready to help you mitigate credit risks and ensure cash flow during these challenging times. What specifically do you need help accomplishing?

As part of your paid subscription to Your Virtual Credit Manager, they provide full access to their archive as well as online consulting - two hours for standard subscribers and five hours with a premium subscription. For larger projects, additional consulting is also available on a fee basis.

Besides answering your questions, you can use this consultation time to have them work with you to accomplish a variety of Credit & Collection activities such as conduct credit investigations, recommend credit limits (or review ones you have established), formulate policies and procedures, collect past due balances and much more. If you are too busy to handle these important tasks, or they’re just not your cup of tea, they're happy to help.

Not a subscriber … why don’t you take advantage of a free YVCM subscription?

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