Trade credit insurance: Future-proofing cash flow for continued growth and peace of mind

By John Catibog  
Last Update – Jan 29, 2019  
Reading – 13 mins

trade credit insurance policy

Businesses today face challenges and risks that would have been unheard of decades or even years ago.

From cyber espionage and to reputation damage, to the age-old threats posed by acts of ignorance, malice or God alike.

There are many things a company can control for and protect itself against through proper vigilance, preparation and smarter business practices.

But how do you protect your business against things you can’t control?

In particular, against the behaviour of others who are less prepared?

If market or other factors force your customers out of business, how do you protect your cash flow so you’re not taken down with them?

This is where trade credit insurance can be a valuable tool in future-proofing your business.

Trade Credit Insurance: In A Nutshell

As you’d expect from the name, trade credit insurance protects businesses and organisations that trade on credit.

In the event of non-payment by a customer, trade credit insurance protects the supplier from suffering a major loss from bad debtors – potentially meaning the difference between continued business or collapse.

Claims on trade credit insurance can be paid in a variety of ways depending on your coverage, from paying the difference in diverting your sale to another buyer, to fully covering the bad debt.

Cost of Trade Credit Insurance

trade credit insurance cost

To determine what this costs, premiums are generally derived by the insurer applying a risk rate to the client’s insurable turnover.

Unlike many more traditional insurance products, there is still a high degree of negotiation and case-by-case assessment that goes into determining trade credit insurance premiums – rather than highly automated or algorithmic processes.

This makes it highly personalised and catering for a wide variety of options and inclusions.

Your risk rating takes into account a number of factors, including your business history and any previous losses, as well as the industry and type of business you conduct.

Beyond this, trade credit insurance is quite adaptable to the needs of your business, so the type of risks for which you want to be covered, as well as the level of cover, will also be considered in determining your risk rating.

Once determined, the insurer establishes credit limits, applies the risk rating to your insurable turnover, and that determines your premium.

The most common event that leads to trade credit insurance claims is when a customer goes into insolvency.

However it can also be triggered by events like protracted default on an invoice, receiverships and external administrations.

In the case of export businesses, which make up a much smaller proportion of the Australian trade credit insurance in Australia, geographic or political events such as war, preventative import legislation or other Government measures can be viable reasons to make a claim on trade credit insurance.

Why Should I Get Trade Credit Insurance?

trade credit insurance application

Trading on credit is an exceptionally common, valuable and long-standing business practice, but that doesn’t mean it isn’t inherently risky.

Beyond protecting your outstanding invoices and recovering debt, there are many benefits to trade credit insurance.

Firstly, greater security means greater freedom to take risks and drive growth.

Knowing that your cash flow and current invoices are safeguarded can provide the peace of mind to be confident in chasing new business.

Secondly, if access to finance is important to your business, then the added safety net of lowering your current credit risk may provide you a boost in the eyes of lenders.

Securing trade credit insurance can also give you greater flexibility in your current business practices, such as the ability to introduce longer payment terms with greater reassurance.

The obvious benefit of trade credit insurance is its protection of your business’s cash flow.

However when you extrapolate from this key advantage, it becomes clear that there are a multitude of additional ways in which this added security can facilitate growth and flexibility.

Trade Credit Insurance Application

trade credit insurance agriculture

The simple answer:

Any business trading on credit can access and benefit from trade credit insurance.

The first major distinction between customer types is the kind of trade you engage in – domestic or export.

This determines the kind of risks, and therefore the degree and type of cover, companies are likely to need.

In Australia, the vast majority of the trade credit insurance market is domestic-to-domestic trade.

Another of trade credit insurance’s advantages is its high degree of flexibility and potential for personalisation.

Because of this, a wide range of industries can take it up and utilise it in different ways, making it more widely applicable.

Here are just a few examples:

• Building & Construction
As insolvency is one of its most common triggers, industries in which this occurs most frequently are of course top candidates for trade credit insurance.

As of the September quarter 2018, the construction industry had the second highest number of insolvencies of any industry type, according to ASIC – a ranking it has held consistently for several years.

This, combined with the high rate of trade credit practices in this sector, make trade credit insurance particularly relevant to the building and construction industry.

• Services
The only sector to top construction in insolvencies, ‘other (business & personal) services’ are another perfect candidate for trade credit insurance.

Particularly when a services business operates without a large number of assets, it is all the more important to insure its receivables.

• Agriculture
This age-old industry sector relies heavily on trade credit, so trade credit insurance provides a way to underwrite the risk of non-payment by distributors, buyers and other customers.

Other industries that can benefit highly from trade credit insurance to protect their profit margins and cash flow are fuel, electronics and transport.

Trade Credit Insurance Claims in Action

To consider how trade credit insurance operates, let’s look at a few hypothetical examples to illustrate how it works in practice.

Halted construction project impacts suppliers

trade credit insurance construction

As part of a major residential development project, huge range of suppliers, contractors and service providers are appointed to bring the construction together on time, and on budget.

In this example, several weeks into the building process the developer has gone into administration and all construction has ceased.

A cabinetry company was appointed by this residential development to produce and install built-in shelving units throughout the building.

Working with the project architects, these shelves have been custom-made to unique specifications for each of the apartments and suites.

At the time the developer goes into administration, the shelving units have been produced and are stored at the cabinetmaker’s facility awaiting delivery and installation.

Given their custom design and the cabinetmaker’s lack of public retail facility, they are essentially unusable stock.

Through further research and negotiation, the company is able to find another buyer who will purchase the units at a discount and retrofit them into their commercial office space.

While the cabinetmaker took a 30% loss on this resale, it was able to make a claim on trade credit insurance to recover the lost funds and cover the additional labour costs to finish installation earlier than expected and on a tighter timeframe.

Advertising client pulls the plug

trade credit insurance advertising

While it may seem a little more abstract, the process above also applies when your business provides services or other intangible products.

Consider an advertising agency running a campaign for its primary client, a major retailer.

This client makes up a large proportion of the agency’s revenue and accounts for a majority of its billable hours.

In this example, the agency has invoiced for its monthly retainer payment, which is due in the next two days.

A further invoice was also issued to cover the additional cost of production and media spend required for this particular campaign.

Until this is paid however, the agency wears the production and media costs of the campaign directly with its suppliers.

At this point in the project, the client goes into receivership and all proactive marketing is halted.

Deposits have been made for the media buy and creative and talent hire costs for the ads have already been paid.

This means the agency is significantly out of pocket but the ads will not run – which may also create reputational issues for the agency with the broadcasters, if not formal financial penalties.

Using some of the flexible options available with trade credit insurance, the agency was able to individually insure this particular client contract because of its significant financial impact to the company.

When the client becomes unable to pay, the agency makes a claim on its trade credit insurance which covers the costs already outlaid for the campaign, as well as the outstanding retainer payment.

Government bans prevent export

trade credit insurance export

In Australia, the vast majority of trade credit insurance clients are businesses operating domestically.

However, trade credit insurance also protects companies operating import/export business, who are impacted by very different market forces.

Consider an example of an Australian mining and resources company which exports valuable mined materials to manufacturers in China.

One contract held by this company is for a large quantity of copper, to be exported to a Chinese electronics manufacturer.

At the time the shipment is prepared, packaged and ready to depart, a division of the Chinese customer is found to be engaging in unethical practices regarding surveillance using its products and breaches of its customers’ privacy.

As a result of unsuccessful negotiations and pleas from international leaders around the world, widespread sanctions are imposed designed to punish and restrict the company’s ability to do business.

The Australian Government imposes heavy tariffs on trade with this company, and as such the mining exporter can not afford to complete the order.

Claiming on trade credit insurance, the company is able to recover the lost revenue from that sale and cover the costs of extended storage of the copper until it is able to redirect the shipment to a new buyer.

Now It’s Your Turn

Trade credit insurance protects your business against the unpredictable – your customers or clients being unable to pay you.

More than this, the added reassurance it provides allows you to chase more business, secure funding, adopt more flexible business practices and ultimately support your operations.

How can we organise trade credit insurance to support your business growth?

Let us know.

Contact us today.