Trade receivables are essentially promissory notes. A company delivers goods or services to another company and issues an invoice. Until the invoice is paid it remains a trade receivable. Credit insurance (also known as trade credit insurance) is a way of mitigating against the unforeseen or unlikely such as a payment default, a large currency fluctuation or a political crisis. The latter risk is greater when dealing with cross-border transactions. This post will look at the benefits of credit insurance and weigh them against the disadvantages of using this type of insurance.
Benefits of Credit Insurance
There are, however, a number of other benefits that using credit insurance brings to a company:
- Support sales growth. A company can move into more markets if they know they have the safety net of credit insurance.
- Improved credit control. To qualify for credit insurance a company needs to set up credit controls. This will improve the overall business as managers will be more cognizant of the financial restrictions on the company.
- Better access to financing. With credit insurance a company can access trade receivables financing, and with better terms. Not having credit insurance makes financing invoices less attractive to funders.
- Increasing exposure limits. An invoice financier will impose limits on spending either by country or by buyer. An invoice financier is likely to increase these limits if there is credit insurance in place.
- Obtaining capital relief. Banks are required to hold certain levels of capital. These limits can be increased to release more working capital if there is credit protection.
The Costs of Credit Insurance
There are drawbacks to using credit insurance. The main one is, of course, cost. An invoice financier will include insurance premiums in the costs for factoring invoices. Further costs include paying a commission to an insurance broker and paying legal fees for setting up credit insurance.
Moreover, there is the cost of setting up credit controls. There are also the audits required by insurance providers to provide up-to-date financial information. While these reports benefit a company, they are still an on-going expense.
In the situation when an insurance claim is made on an invoice payment default the insurer will take charge of the claims procedure, potentially even taking a customer to court to reclaim loses. The intervention of credit insurers into business relationships can sour those relationships.
It is the nature of B2B that there is a gap between delivery of goods and services and payment for those goods and services. During this time things could drastically change. To mitigate against this risk credit insurance is the best option. A financing company without credit insurance risks bankruptcy. See our article about Greensill Capital.
It also comes with other benefits such as better and cheaper financing options, credit control checks, and the chance to increase credit limits to drive company growth.
These benefits need to be weighed against the on-going costs of using credit insurance, and the possibility that a credit insurer might directly interact with a customer that is struggling to honour an invoice.