How to assess and reduce customer default risk

9 May 2024


  • Reducing the risk of your customers defaulting on a payment is vital for maintaining your cash flow and avoiding time consuming credit control processes.
  • There are several warning signs to look out for which indicates that a customer could be at risk of defaulting, from frequently paying late to being difficult to get hold of.
  • Customer default risk can be assessed and mitigated against so you can confidently take on larger customers and grow your business.  
Get the latest insolvency insights sent straight to your inbox

Default risk in the context of insurance, specifically trade credit insurance, refers to the risk that a customer doesn’t pay an outstanding invoice, or account receivable owed to the seller by customers who become insolvent, bankrupt, or otherwise unable to fulfil their payment obligations.

This varies slightly to the finance and lending world, where default risk refers to the risk that a borrower doesn’t make the required payments on a debt or meet other terms of a loan obligation. While both usages relate to the risk of non-payment, in insurance it’s about protecting businesses from customer defaults.

For the purposes of this article, we’re looking at default risk in relation to insurance and how businesses can protect themselves from financial shortfall if a customer can’t pay their invoices.

Running a business means facing numerous challenges, one of which is the uncertainty of when, or even if, customers will pay their invoices. The lingering effects of the pandemic have stoked legitimate concerns over a potential surge in bad debts, as companies find themselves compelled to prioritise self-preservation to weather the storm, rather than fulfilling financial obligations to suppliers.

It’s not always easy to spot the signs that a customer is a default risk, but here are some of the common red flags:

  • Paying consistently later than agreed terms.
  • Being difficult to contact or get hold of people at the business.
  • High staff turnover or frequent leadership changes.
  • Worrying signals in their financial statements or credit reports.

Trade credit has become an integral tool for businesses to manage their cash-flow, allowing suppliers to extend the standard 30-day payment terms, affording customers additional time to settle invoices for goods or services rendered.

Businesses negotiate trade credit terms based on the customer’s perceived creditworthiness, but problems arise because a supplier is often the last to know when a customer’s business is in financial difficulty.

Here are some ways you can avoid customers defaulting on their invoices:

  • Establish and communicate clear credit policies, terms, and overdue payment penalties.
  • Request deposits or split invoicing for large orders.
  • Thoroughly vet new customers before extending credit.
  • Consider trade credit insurance to protect against non-payment.

While completely removing default risk when extending credit may not be realistic, adopting prudent and consistent measures can significantly mitigate exposure, fortifying your business against the potential financial damage of customer defaults.

Before extending credit, it’s vital to evaluate a potential customer's creditworthiness and ability to pay using the "5 Cs of Credit":

  • Character - Their history of making payments on time.
  • Capacity - Current cash flow supporting future payments.
  • Capital - The customer's overall net worth and asset protection.
  • Collateral - Secured assets for the credit being issued.
  • Conditions - Economic and industry factors affecting them.

Gathering data from financial statements, credit reports, trade references and public records can provide insight into these factors. However, sources may not always reflect the latest real-time information.

In an unpredictable economic climate, trade credit insurance (TCI) emerges as an indispensable protection, shielding cash flow from the impact of overdue payments and the cost of unrecovered debts.

By transferring the risks associated with customer default risk, TCI empowers companies to forge ahead with renewed confidence, safeguarding their cash flow, and fostering a more robust and adaptable enterprise allowing them to take on bigger clients at home and overseas.

With a TCI policy from Allianz Trade, you will get access to up-to-date financial information on customers, providing you with clear direction on whether credit can be extended and to what level. This completely removes the need to vet customers yourself and you can be safe in the knowledge that should a customer not pay, you’ll be able to make a claim to recover the loss.  

To find out more about reducing customer default risk with TCI, get in touch with our specialist team for a free consultation on 0800 056 5452.

For a free credit insurance consultation call our UK team, 09:00-17:00 Mon-Fri.