Credit Management Options Comparison | Allianz Trade credit in HK

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Feature	Credit insurance	Letter of credit	Factoring	Self-insurance
Costs	$	$$$	$$	$ Cost of opportunity and bad debt reserve
Cover / protection against credit risk	Yes, insolvency, protracted default and political risks	Yes, buyer default	Yes, Insolvency and protracted default if non-recourse finance	No
Additional services	Yes, credit risk information, risk assessment, market intelligence, debt collection	No	Yes, debt collection and credit information	No
Financing	No, but can facilitate financing	No, but can facilitate financing	Yes, converts invoices into cash for a fee	No
Customer relationships	Your customer is unaware of credit insurance contract. Better terms of payment enhance relationship	Both are aware of the set up	Collection by factor of trade receivable may affect client relations	Maintains direct relationship with customer

Bad Debt Reserves vs. Factoring vs. Letter of Credit vs. Credit Insurance

Option 1: self-insurance (bad debt reserve)

Definition: Use of a bad debt reserve to offset losses should any customers become unable to pay

Pros of Bad Debt Reserves:

Minimal cost to the company in years with no losses
Simple to administer

Cons of Bad Debt Reserves:

Company bears burden and cost for internal credit management resources needed to mitigate risk
Depending on risk tolerance, may result in overly conservative limits that reduce potential revenue
Ties up working capital that impacts capital allocation of the balance sheet
Typically does not protect from large and unexpected catastrophic loss
Utilize unreliable third party data services

Option 2: factoring

Definition: An agreement with a third party company to purchase accounts receivable at a reduced amount of the face value of the invoices

Pros of Factoring:

Immediate access to cash
Option to outsource invoicing, collections, and other bookkeeping activities
No long-term contracts
Doesn't require collateral

Cons of Factoring:

Depending on contract structure, may not protect against non-payment events
Loss of control of customer relationships
Capacity constraints associated with line availability
Cost range between 1% and 4% of a receivable plus interest on the cash advance that can equal up to 30% in annual interest
Does not indemnify full invoice

Option 3: letter of credit

Definition: A bank guarantee that the payment of a buyer's obligation will be received on time and in the correct amount

Pros of Letter of Credit:

Security for both seller and buyer
Financial standing of the buyer is replaced by the issuing bank
Because of the guarantee, seller can borrow against the full receivable value from its lender

Cons of Letter of Credit:

May only cover a single transaction for a single buyer and can be tedious and time consuming
Expensive, both in terms of absolute cost and credit line usage with the additional need for security
Ties up working capital for the buyer
Competitive disadvantage when competitors are offering open terms
Lengthy and laborious claims process

Option 4: credit insurance

Definition: A business insurance product that protects a seller against losses from nonpayment of a commercial trade debt

Pros of Credit Insurance:

Empowers companies to confidently gorw sales without credit concerns
Guaranteed protection against non-payment, late payment or unpaid invoices.
Enhances efficiency of a company's internal credit department with fast credit limit requests and ongoing buyer monitoring
Allows exporters to offer safe, open payment terms overseas
Expands a company's financing options by increasing its borrowing base with secure receivables

Cons of Credit Insurance:

Most cost-effective for businesses with USD $2M+
Not suite for companies with only government or B2C sales

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_{Credit management is defined as your company’s action plan to guard against late payments or unpaid invoices by your customers. An effective credit management plan uses a continuous, proactive process of identifying account receivable risks, evaluating their potential for loss and strategically guarding against the inherent risks of extending credit. Having a credit management plan helps cash flow forecast, optimizes performance and reduces the possibility that a default will adversely impact your business. Late payment and payment default situations happen with alarming frequency – it’s critical to the financial health of your company to minimize them. Many businesses find it challenging to properly evaluate and track the creditworthiness of new customers. And when conducting business with foreign customers, customer's credit risk management becomes even more complex because it can be difficult to interpret and rely on information used by foreign countries to measure creditworthiness.}