BY DON SADLER
STARTING AND MANAGING a small
business involves lots of different risks.
One risk that many small-business owners don’t adequately address is customers
who can’t or won’t pay their invoices.
Unfortunately, this risk is all too real.
Accounts receivable typically represent
more than ;; percent of a company’s
assets, and one out of ;; invoices eventually becomes delinquent, with many of
them becoming unpaid debts.
One way that a business can mitigate
the risk of nonpayment of invoices is purchasing trade credit insurance. This type
of policy pays out if a covered invoice is
not paid by a customer.
The balancing act
“Small-business owners must con-
tinuously balance the cost of doing busi-
ness with the risk of doing business,” says
James Daly, a Costco member and the
CEO of Euler Hermes for the Americas, a
provider of trade credit insurance (euler
hermes.us). “Far too little analysis is done
with respect to the effect of bad debt
write-offs on the bottom line and what
can be done to avoid that impact.”
With trade credit insurance, you can
choose which customers’ invoices you
want to insure; it’s not all or nothing.
You can insure your largest invoices to
guard against the risk of a potentially
catastrophic nonpayment, or you can
insure the receivables of your less credit-
worthy customers.
According to Daly, the insurer will
analyze the creditworthiness and finan-
cial stability of your insurable customers
and assign them a credit limit (this is the
amount the insurer will indemnify if the
customer fails to pay). Trade credit insur-
ance policies may cover nonpayment for
such reasons as a customer’s bankruptcy,
insolvency or closure of the business.
An added benefit of purchasing trade
credit insurance is that the insurer will
continually monitor the credit of customers whose invoices are insured. “This helps
small-business owners make informed
credit decisions and thus avoid or minimize losses,” says Daly. “Access to this
information also gives businesses the confidence to make better strategic decisions.”
Right for you?
How do you determine if purchasing
trade credit insurance is a wise move for
your company?
Gene Siciliano, a Costco member and
financial management adviser known
as Your CFO For Rent (
cfoforrent.com),
recommends applying your historic collection loss ratios against your current
outstanding accounts receivable.
“Then compare your annual bad-debt
write-off cost to the amount of the insurance premium for the same period,” he
says. “Next, consider what you could do
to improve your credit granting and collection practices. If these measures could
reduce your collection losses, redo the
comparison analysis with these implemented and choose the option with the
lowest net cost.”
“We no longer worry”
Izzy Eisenberg, the CEO of Packaging
Methods Defined in Princeton, New
Jersey, decided to purchase trade credit
insurance a few years ago. “After picking
up a large new account, I thought I might
need this type of insurance,” he says. “It
has helped tremendously because, when
dealing with large clients, we no longer
worry about getting paid. And this helps
me make better financial decisions.”
Siciliano says the decision to purchase
trade credit insurance ultimately comes
down to whether you feel you can man-
age collections risk adequately without
buying coverage: “If you can’t mitigate
or eliminate collections risk with better
management practices or pass this risk
on to someone else, then you insure it.” C
Don Sadler is an Atlanta–based freelance
writer who specializes in small business.
Covering
your risks
BUSINESSCONNECTION
Is trade credit insurance
right for your business?
YOU HAVE FOUR main options for
mitigating credit risk:
1. Self-insurance. This involves
setting aside bad-debt reserves in
a liquid account that can offset the
deficit if a customer doesn’t pay a
large invoice.
2. Factoring. A factor will purchase your accounts receivable at
a discount and assume the risk
of nonpayment.
3. Letters of credit. A bank will
issue a letter of credit agreeing to
guarantee payment of a buyer’s
obligation on time and in full.
4. Trade credit insurance.
This guarantees that nondisputed
accounts receivable will be paid
by the debtor or insurer according
to the policy terms.—DS
OPTIONS FOR
REDUCING CREDIT RISK © MAXUSER / SHUTTERSTOCK
