John F. Kennedy once said that “a rising tide lifts all boats” to illustrate the idea that everyone benefits from a strong economy. Although the accuracy of this macroeconomic view may be challenged, its optimism cannot. However, if this premise is correct, then the opposite must also hold true – a falling tide lowers all boats. Unfortunately, since the economy appears to be in the midst of the lowest tide in distant memory, this could prove disastrous for many businesses.
During difficult economic times – low tides, if you will – many consumers shift into survival mode by cutting costs to the absolute minimum and stretching dollars to the absolute maximum. Despite their best efforts, however, many are left insolvent and unable to pay their bills. If one of these commercial consumer’s bills happens to be one of your accounts receivable, then you may find your boat sinking along with the rest; a victim of the falling tide.
The importance of protecting commercial accounts receivable during a struggling economy cannot be overstated. An account receivable is money owed by a customer for products or services that were provided on credit. It represents dollars a company does not have at its disposal to pay its obligations, reinvest in inventory, or finance growth. And, since accounts receivable are treated as a current asset on a balance sheet, the loss of receivables can jeopardize a company’s financial stability on multiple levels, from making payroll to obtaining financing.
The most effective method of protecting accounts receivable is to only do business with financially strong commercial customers. Unfortunately, the increasing difficulty of locating such customers has left many businesses considering the option of eliminating the practice of providing goods or services on credit, thereby foregoing the maintenance of accounts receivable altogether. However, the extent to which sales on credit are embedded as an ordinary business-to-business practice in many industries renders this option unrealistic.
Yet, there is another way businesses can protect their accounts receivable – credit insurance. Credit insurance, sometimes called accounts receivable insurance, provides protection against the commercial risk created by customers who fail to pay, or delay in paying, their open accounts. For instance, credit insurance can protect against the loss created by a customer with an open account who files bankruptcy, struggles with cash flow issues, or lacks sufficient insurance to withstand an adverse liability judgment.
Credit insurance is not new (it has generally been available in some form for over 100 years), but the ever-increasing number of customers defaulting on their open accounts has recently brought more attention to this risk management product. Hence, more and more businesses are considering whether credit insurance is for them.
Other than the obvious benefit of satisfying a defaulting customer’s open account, credit insurance may offer other benefits as well, including the reduction of collection costs, the reduction of bad-debt reserves, and an overall strengthening of the balance sheet. Moreover, credit insurance may serve to enhance a company’s financing relationships since insured accounts receivable are considered stronger collateral than non-insured or mature receivables. Lending institutions may consider the insured receivables when calculating a business’s borrowing base, thereby allowing the business to achieve more favorable financing to fund growth. By strengthening the balance sheet, credit insurance may also serve to increase the value of the business in the eyes of prospective purchasers.
Although credit insurance may not be necessary for every business, those sharing certain characteristics may want to consider giving the prospect of purchasing such coverage a closer look. If the following statements represent your business, then you may be a good candidate for credit insurance:
- Does your company provide commercial goods or services on credit?
- Would the non-payment of one or more of your large commercial accounts jeopardize your company’s ability to continue as a going concern?
- Does a small percentage of your commercial customer base make up a significant portion of your accounts receivable?
There is an additional factor that should be considered – sales in foreign markets. Several credit insurance products also protect against foreign political risks that may prevent or delay payment, such as a war in the customer’s country, cancellation of a contract by the government of the customer’s country, or adverse regulations imposed by the government of customer’s country which prevent or restrict consummation of the transaction.
During any time, but especially during difficult economic times, risk-free ventures are virtually impossible to come by. However, as with any insurance product, the goal is to reduce the risk to a manageable level so the focus can optimistically remain on the upside potential of a business venture rather than the debilitating downside.
So, if one or more of these conditions apply to your business, raising the option of obtaining credit insurance may not be a bad idea. Let us know if you would like to discuss your risk management options.