the importance of trade credit insurance

The Value in Trade Credit Insurance

September 28, 2022Cash Flow

Trade credit is a critical source of business funding for those operating in Australia.

Trade credit allows a company to provide goods and services before payment is received, usually on interest-free terms with backing from nonfinancial institutions.

Net terms are vital to wholesale product suppliers and most supply chains, but while necessary, this system can also present a serious liability.

To reduce the risk of bad debt for small to midsize enterprises, trade credit insurance could be a necessary investment.


Understanding Trade Credit Insurance

Credit insurance policies are appropriate for businesses of all types and sizes, but an SME can especially benefit from the protection provided when extending services like trade credit.

Trade credit insurance is used to insure your company’s accounts receivable and gives your business a failsafe against unpaid invoices.

It also goes by the terms business credit insurance, export credit insurance, AR insurance, debtor insurance or credit insurance.

Non-payment concerns go far beyond just a bad-faith deal made with a buyer. Other possible reasons for non-payment include:

  • Political unrest
  • Economic collapse
  • Currency fluctuations
  • Bankruptcy
  • Natural disasters
  • Ownership changes

Credit insurance is written to address the specific needs of your company, with the insurers covering both direct loss costs and indirect costs.

Direct loss includes the invoice amounts, while indirect costs would include interest payments on loans that were secured using receivables or the costs for going through collections on an invoice that is insured.


Knowing How Trade Credit Insurance Works

SMEs understand the serious problems associated with bad debt, but there is equal pressure to not lose out on accounts and sales because of weaker bargaining power against larger suppliers that offer net terms.

Trade credit is important for staying in business, and credit insurance can protect you if your customers fail to pay.

Even when you make careful decisions concerning wholesale applications and who is eligible for trade credit with your company, things can go beyond your control and invoices can fail to be paid.

Credit insurance makes sure you get paid even if the buyer fails to meet their invoice obligations.

Businesses use this insurance for both domestic and international trade accounts, with the level and cost of the coverage depending on the extent of the credit portfolio, the market location, and the level of risks associated with the customers.

Such insurance makes it easier to attract new customers and explore growth opportunities in new markets, as the transactions and risks are secure.


Policy Applications

Your business will establish one account with an insurer, but then each customer is granted a credit limit based on a thorough analysis of that company’s creditworthiness.

Some insurance companies allow the insured to determine the limits based on the personal knowledge of the customers.

Regardless of how it’s done, your company maintains control over which accounts you include in trade credit insurance coverage.

Any business selling goods or services can purchase a policy, and you pay a premium and deductible just like on other insurance policies.


Cost of Policies

You will be charged a percentage of your company’s sales when the insurer sets the cost for your policy.

However, factors like where you do business, previous losses, the nature of your industry, internal credit procedures, the extent of coverage requested and the creditworthiness of your customers also impact the cost.

You can estimate credit insurance to cost around one to three cents per dollar.

If your total annual revenue came in around $50 million AUD, your premium cost could range between $30,000 to $100,000 to cover accounts receivable.


Limitations With Policies

The terms and conditions of trade credit insurance vary by insurer, but there are standard coverage limits in place across the industry.

This is why it’s important to find out how much the insurance could help you before you sign for a policy.

Many policies cap the payouts between 75% to 95%, leaving your company liable for the remaining invoice amount as well as the deductible for the policy.

Another limitation is that filing a claim and receiving a payout takes time.

Even after you fill out the proper forms to submit the claim, the insurance company might request additional information or get into a discussion concerning the claim before it is approved.

After approval, it could still be several days or weeks before you see the payout issued.

While it’s better to get partial payment on an invoice instead of losing out on the whole amount, credit insurance isn’t an instant fix to bad debt problems.


Benefiting From Trade Credit Insurance

Protection against non-payment is a leading motivation for purchasing credit insurance, but there are several other benefits to making this investment.

These give your company more financial stability and improve growth opportunities.


Expanded Sales

Issuing too many approvals to trade credit applications could leave your company in a bind if two or three of your customers default on their responsibilities.

Insurance means you are safely able to take on new customers or close new deals because the risks associated with non-payment have been mitigated.


New Market Expansion

As your business grows, you may need to expand beyond the local or domestic market to increase revenue.

Exporting overseas or working with international customers brings another level of risk that credit insurance can help minimize.


Better Finance Terms

If your company needs financing, a lending institution will look more favorably at your situation if you have credit insurance in place.

There is security in knowing that a majority of the bills will still be paid even if the accounts default.

Banks prefer clients that have insured their accounts receivable.


Cash Flow Relief

Your business runs into problems when the cash stops coming in. Cash flow relief helps cover your potential losses before your company suffers serious damages.


Supplementing Trade Credit Insurance

Although you can purchase trade credit insurance as extra protection against bad debt, you can reduce the risks of your credit accounts from the initial application.

With PencilPay’s digital platform, you have everything you need to determine credit worthiness, manage trade credit, accept payments and notify accounts of past due invoices. Book a demo today to find out more.