Credit Insurance: Why a Handshake is No Longer Enough

The old Kiwi ‘she’ll be right’ mentality when managing credit risk is no longer sufficient in the modern era. David Meys from Coface Credit Insurance examines why a handshake is no longer enough.

Senior managers and directors have considerable responsibility to ensure that all threats to the sustainability of their businesses are controlled and managed.

Among other governance functions, directors can often lose sight of the fundamental processes of managing credit risk.

40 per cent of a typical company’s assets are in the form of its outstanding sales ledger – credit risk often being the company’s largest and most likely to blow an organisation up.

This cornerstone of any business is often undertaken by untrained staff, who have risen through the ranks, to inherit dysfunctional credit processes. They are often unaware of the true risks they are running.

Approving credit terms based on a trade reference and a handshake are no longer sufficient and lessons unlearnt following the GFC are still affecting New Zealand businesses today with NZ companies losing billions a year by just accepting bad debts are part of the way we do business.

High profile domestic failures are becoming common place and looking offshore, increasing conflict, financial instability, geopolitical tensions and more are shaping today’s credit and political risk landscape.

Given this backdrop, companies are reassessing their risk management strategies and seeking to manage volatility, secure existing operations and safeguard credit risk. The function of the board in this area is to provide direction and challenge of credit risk-taking, setting a credit risk control framework and providing a structure within which credit risk is managed.

This is a time for companies to place even greater scrutiny on their customers and potential customers or trading markets. Directors may want to ‘look for the bad news’ in assessing sales opportunities and ask; ‘what will happen when this transaction goes wrong?’

For example, if your business operates on a profit margin of 5 per cent, a bad debt of $200,000 will require additional sales of $4,000,000 to make up for that loss. Can the company sustain this?

The reality is that despite the best credit control procedures, at some point every company will incur a loss.

It’s impossible to know if debtors are keeping up with their tax payments, breaching their bank covenants or when they themselves are struck with a catastrophic bad debt they cannot sustain.

As a baseline, typically 3 per cent of transactions are written off each year. Aside from the impact this has on cash flow, the angst involved in collections action, legal action and in fighting preference payments demands can be at best a hand brake to growth.

New Zealanders wouldn’t dream of leaving their house uninsured against fire, yet commonly do by betting their house on their debtor’s ability to pay.

As New Zealand companies have expanded and globalised over the past 20 years, many have found that, like their global counterparts, using credit insurance to protect accounts receivables from unforeseen losses due to non-payment can be critical to their success.

Coface Trade Credit Insurance

Credit insurance helps companies to operate through unpredictable economic cycles by protecting accounts receivable from losses caused by the insolvency, protracted default or political events.

Cover is sought on a buyer, assessed by an insurer (who typically has financials), then underwritten, meaning a company can then increase trade with confidence and obtain bank funding based on these deals now being securitised.

Credit insurance is very cost effective at around just $250 per $100,000 of turnover insured. It plugs the hole of throwing good money after bad by covering not only the cost of bad debts, but also the collection and legal costs of recovery, (which can often end up being higher than the original overdue amount), plus any preference payment demands under the insured limit.

Structured according to your specific requirements, it can be designed for domestic sales or export sales, to help protect against unexpected bad debts, preserve cash flow and protect profitability.

Trade credit insurance is for companies that:

  • Conduct business on open credit terms
  • Want their enterprise risk management philosophy to be applied to financial management
  • Have accounts receivable concentrations
  • Seek asset-based lending arrangements with banks
  • May not collect sufficient credit information on their own customers and value a credit partner to access credit risk

By purchasing credit insurance, your organisation may be able to:

  • Increase sales by offering buyers more competitive payment terms
  • Confidently sell to new customers in a variety of regions
  • Release bad debt reserves for either reinvestment or as a dividend to shareholders

Companies may also improve their financing arrangements with banks by increasing advance rates, improving pricing, or obtain other structural benefits to existing financing arrangements.

Trade credit insurers maintain extensive databases of companies worldwide, including information on balance sheet strength, sales histories, payment records, and financial ratios.

A trade credit insurance policy can help you gain access to this data to support your sales expansion.

Taking the time to question your company’s credit management practices could be the thing that makes all the difference to the bottom line.

Making informed decisions, based on a cost benefit analysis of transferring credit risks to an insurer where appropriate, is prudent and something a company should be doing each year.

A well-designed credit programme shows stakeholders that your organisation has a proactive risk strategy to address known risks within your customer portfolio. These programmes may be disclosed within your organisation’s financial statements to demonstrate a conservative, prudent approach to risk management and good corporate governance.

For more information about Credit Insurance, please contact your broker or David Meys at Coface directly at David.Meys@coface.com

 

Disclaimer

Conditions apply for each policy and the information expected from you for a policy to trigger. Coverage may differ based on specific clauses in individual policies. Please ask your broker to explain the additional benefits and exclusions pertaining to your policy.

The information provided is general advice only and does not take account of your personal circumstances or needs. Please refer to our financial services guide which contains details of our services and how we are remunerated.

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