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What Experts Think

What Is Credit Risk Exposure

To understand what credit risk exposure is, we first need to understand exactly what credit risk itself is. Credit risk is the risk posed to a company if a third party client they loan to does not honor an agreement, usually the repayment of money. Credit risk exposure is the total and maximum amount of money you could lose if all your third party clients fail to honor their payment agreements. This credit exposure is often calculated in relation to specific types of agreements such as repayment loans or long-term contracts.

Understanding your credit exposure is part of risk management for your business. Once you have conducted an audit on your core operations and identified your default risk, you are able to take steps to ensure the security of your company and reduce your credit risk exposure.

Client Selection

Careful client selection is the first step in monitoring and reducing credit exposure risk. It is important to limit and lower your risk by conducting a credit analysis on potential clients prior to selection. Look for clients with higher credit ratings as they will be more likely to uphold their agreement and repay the loan. This does not mean that you should not take on clients with low or no credit rating, rather use this information to tailor the loan agreements you offer to them.

Controlling Credit Exposure

Controlling your credit risk exposure is critical, especially now in such uncertain economic times. A common way to reduce risk is to introduce penalties and new loans with a higher interest rate. These measures aim to deter clients from missing a payment and mitigate the loss that may arise from a potential missed payment. This particular method is often utilised by banks, however there are a number of other ways lenders can control their risk exposure.

Setting credit card limits or altering the principle and interest amount based on the clients expected likelihood to repay the sum owed is another example of this. This may take form by offering a reduced loan to a student with no credit history, or offering a high value loan to a client with an excellent credit rating. Utilising this method will enable you to reduce your credit exposure risk by lowering individual credit risk of certain clients.

Purpose of Credit Insurance

Some risk is inevitable, that’s just the name of the game when it comes to business. Recent months have shown just how unpredictable the economy can be with many businesses falling victim to the devastating effects of the Coronavirus. It is more important than ever to ensure your business is protected against the unknown.

Studies have shown that the majority of business failures are not due to lack of sales or opportunity, rather due to poorly managed cash flows and increased credit risk. Many business owners have found themselves ignoring cash flow and credit risk in favour of focussing on revenue and sales. While this problem may directly affect your clients, it will indirectly affect your business if you do not have adequate measures in place to protect yourself from credit default.

Credit insurance is the best and safest way to ensure your business is protected against concentration risk and counterparty credit risk. Your business may also be exposed to commercial risks such as if your clients are unable to pay within the agreed time frame, or become insolvent. In these cases your insurance will cover things such as the standard services or goods that are sold.

Credit insurance plans are customisable and can be tailored to meet the specific needs of your business including risks such as binding contracts and works in progress. Credit insurance is vital for businesses of any size to help protect their cash flow and ensure the business is able to continue trading with no issues.

Get Serious About Protecting Your Business

Niche Trade Credit has over 30 years experience in credit management and credit insurance services. If you are serious about protecting and growing your business, contact us today on 02 9416 0670.

*DISCLAIMER: No person should rely on the contents of this publication without first obtaining advice from a qualified professional person. This publications sold on the terms and understanding that (1) the authors, consultants and editors are not responsible for the results of any actions taken on the basis of information in this publication, nor for any error in or omission from this publication; and (2) the publisher is not engaged in rendering legal, accounting, professional or other advice or services. The publisher, and the authors, consultants and editors, expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this publication. Without limiting the generality of the above, no author, consultant or editor shall have any responsibility for any act or omission of any other author, consultant or editor.

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What Experts Think

Trade Credit Insurance Vs. Factoring

If you’re part of a business that has many international clients, you’re probably somewhat familiar with trade credit insurance and factoring. But you may be a bit confused about the difference between the two, how they are related – and how they’re different.

In this article, we’ll explain all of the basics, to help you understand the differences, and what may be right for you, to protect your accounts receivable and make sure you get paid on the due date of your invoice.

The Basics Of Trade Credit Insurance

Trade credit is, essentially, the credit line that your company extends to another company when they purchase your goods or services. If you bill someone on “Net 30” or “Net 60” terms, and they have 30-60 days to pay you, you’re extending them a line of credit.

You can incentivize your clients to pay by offering small discounts – such as a 2% discount – for paying within a certain time period. However, if your client does not pay, what happens?

If you do not have this type of insurance, you may have to send this bad debt to a number of collections services, and try to get the money you’re owed from your client. But this can take quite a bit of time, and you may never get the full amount you’re owed.

This is what trade credit insurance companies are here for. Ths type of insurance is used for credit protection. Essentially, you take out a policy on your invoices. Then, if an invoice is not paid for some reason, the insurance company will pay you a percentage of that invoice’s value – based on the premiums and coverage you’ve negotiated.

Understanding Factoring

While credit insurers insure you from a client who refuses to pay, a factoring company gives you a way to get working capital for your company, by using your outstanding invoices as collateral.

Wondering about the basics of how factoring works? Basically, a factoring company will buy your invoices for a set percentage of their value – usually around 80%. You’ll get that money immediately.

Then, once your invoices have been paid to the factoring company, you’ll get the rest of their value – minus any applicable fees. This may sound somewhat similar to trade credit insurance, but it is not – for one big reason.

Factoring Usually Does Not Protect You From The Risk Of Non Payment

The big difference between trade credit insurance and factoring is that factoring is not a way to protect yourself from the risk of non-payment. This is because most factoring companies use “recourse factors.”

A recourse factor agreement states that, once the terms of the initial invoice have eclipsed and the debtor refuses to pay, you must purchase that invoice back from the company – and your credit department must continue pursuing the debt on their own.

It is very rare to work with a company that does not use recourse factors. Those that do offer non-recourse factoring typically charge an extremely high fee – and they only pay for bad debt if it’s caused by bankruptcy. If the client simply refuses to pay or disappears, you still have to buy back their invoice from the factoring company.

Essentially, you cannot hope to get rid of bad debt by offloading it onto an invoice factoring company.

When Should I Use Trade Credit Insurance Or Invoice Factoring?

If you are worried that your invoices won’t be paid – because you’re exporting to a newer company, or because you’re working in a politically unstable region – trade credit insurance is what you’ll want. Even if your client never pays you for your goods or services, you’ll be able to recover most of the value of the sale, and ensure your business stays in good financial shape.

In contrast, invoice factoring should be used when you’re sure that your clients will pay eventually – but you’re having short-term cash flow problems. Maybe you’ve got a few dozen Net 60 invoices out there, but you need to make payroll and invest in some upgraded equipment within the next month.

By using a factoring company, you can access the money you’re owed more quickly, and use it for mission-critical operations and other business needs. Just don’t think that you’ll be able to “dump” bad debt with invoice factoring – The use of recourse factors mean that this is simply not possible.

Learn More From Niche TC Now!

If you’re running a business in Australia, and you need tarde credit insurance, Niche TC is the best choice.

To get more information about our services, and get a quote for your company, please get in touch with us online right away, or give us a ring at 02 9416 0670.

We’d be happy to continue this discussion with you in-person, and help you develop a deeper understanding of the benefits of trade credit insurance services.

*DISCLAIMER: No person should rely on the contents of this publication without first obtaining advice from a qualified professional person. This publications sold on the terms and understanding that (1) the authors, consultants and editors are not responsible for the results of any actions taken on the basis of information in this publication, nor for any error in or omission from this publication; and (2) the publisher is not engaged in rendering legal, accounting, professional or other advice or services. The publisher, and the authors, consultants and editors, expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this publication. Without limiting the generality of the above, no author, consultant or editor shall have any responsibility for any act or omission of any other author, consultant or editor.