International trade can be rewarding, but unless there is some protection against debts, there will likely be losses for some companies. If you’re into overseas trading, there is a need to safeguard your business from bad debts. But what is the best way to do so? Should you use export credit insurance or letters of credit?
Generally, both export trade insurance and letters of credit are excellent trade credit insurance policies you can use to mitigate cash flow issues, political risks, and payment troubles. However, you should choose an option that provides comprehensive coverage to satisfy your business needs.
Understanding a letter of credit
You can think of a letter of credit as a financial backstop that protects both your company and your customers. This means you will receive payments for goods and services even if customers default on payments. A letter of credit is a commitment by a financial institution to cover the entire or remaining amount of the debt if the buyer cannot pay on time.
An importer is expected to carry a letter of credit if they are likely to fail to pay as per the payment terms. In most cases, a letter of credit will cost up to 3 per cent of the transaction. Remember that the issuing bank will only settle the debt if the delivery fulfils the required conditions, including on-time delivery and quality of goods.
While a letter of credit guarantees financial security, it isn’t without drawbacks. It can be tedious, time-consuming, and costly in terms of credit line insurance, total cost, and working capital. Also, as a buyer, you must seek a letter of credit from your bank before a shipment. You may also need to provide additional security to meet the bank’s coverage needs. Fortunately, there are more viable options, like export credit insurance.
What Is Export Credit Insurance?
Export credit insurance is a financial policy that safeguards a company’s accounts receivable from bad debts. Other names for export credit insurance are trade credit insurance, debtor, or receivable debtor.
This credit insurance works by protecting your business cash flow from the risk of non-payment. It covers all the invoices sent to customers and ensures that the payments are made even if the debtor is in protracted default or bankrupt.
Based on your agreement with your insurance company, you can insure a single customer, a single invoice, or multiple accounts. In case of customer default, your insurer will compensate you up to your coverage limits, which can be 85 to 100 per cent of your export sales. Keep in mind that some insurance companies can impose credit limits on your transaction amounts.
Which Policy Is Right for Your Business?
The type of credit insurance policy you choose will depend on various factors. For example, a letter of credit may be a great way to build trust and establish a relationship with a new customer. But if you want to recover bad debts without involving the bank or debt collection services, you’d be better off with export credit insurance.
Need help? Contact Niche Trade Credit for all your export credit insurance needs. We offer professional advice to help you make an informed decision regarding your business coverage.
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