While trade credit is a powerful commercial tool for conquering new markets and building customer loyalty, it is also a double-edged sword that can enhance your working capital and cash flow. As part of your financial management strategy, trade credit insurance can help you control the risk of running short on working capital.

How Trade Credit Affects Cash Flow

Cash flow is a central operational driver for your business. Thanks to this indicator, you can efficiently manage your daily operations, like wages and invoices, as well as investments in your future growth. Granting your client trade credit has advantages but also creates an account receivable that weighs on your working capital. It is cash that is not collected on the date of invoicing, so it creates a cash flow gap.

In the U.S., nearly one third of small business owners declare they wait more than 30 days for payments (source: Forbes 2019)

Above all, you expose yourself to credit risks such as late payment or non-payment. Your trade receivable may then become a bad debt, which is equivalent to a temporary or permanent loss of cash with respect to your financial projections.

Such bad debt is potentially very difficult to recover, especially if your client goes bankrupt. So you should be prepared to deal with late payments and invest in efficient payment monitoring and recovery processes, if necessary through a debt collection agency.

Nevertheless, internal debt collection involves significant costs in terms of human and technological resources – costs that an SME may not be able to afford.

Implementing a wise cash flow management policy

Luckily, there are some essential best practices you can follow to manage your trade credit risk:

  • Know who you’re dealing with. Make sure you’ve evaluated your client’s creditworthiness before trading with a new customer. 
  • Negotiate clear and appropriate payment terms. 
  • Set up credit limits with your clients. The amount of credit you grant should not go above your pre-determined threshold. 
  • Strengthen your invoicing process and invoice payment monitoring. 

Should the client fail to meet payment deadlines, you may require penalties and interests. As a last resort, the client's assets may serve as a backstop guarantee. 

It’s important to continuously monitor your cash flow position and adapt your trade credit policy accordingly. Check out our ebook, “How to Protect Your Cash Flow,” for in-depth insights.

Benefits of improved cash flow management

Improved cash flow management means your business will be secure in meeting its own monthly payment obligations and open to more opportunities for growth. Benefits of improved cash flow management include:

  • Clear fiscal insight – With improved cash flow management, you’ll have a clear picture of your company’s up-to-date income and expenses – important indicators of your organization’s financial health.
  • Early warning signs – It’s important to recognize, as soon as possible, if any of your customers pose a significant risk to your business. Improved cash flow management will help you stay on top of customer credit checks and stay alert for ‘red flags,’ such as customers looking to change payment terms and non-stop excuses as to why they can’t pay you.
  • More accurate predictions – By bringing together all your information in both a current cash flow statement and a prediction of future cash flow, you’ll be aware of opportunities and risks going forward. These statements and projections are only useful if you learn from them, so set aside time each month to compare real-world figures to your projections.
  • Streamlined invoicing and late-payment processes – With improved cash flow management, you’ll be able to keep better track of your invoices, making sure they’re issued as soon as possible and following up with your customer as the due date approaches – especially if the invoice is for a large amount. If your customer misses a payment deadline, you’ll know to keep up the dialogue, apply interest or penalties for late payment, and remind them that you will not accept non-payment. Keeping information about your invoices in an accessible format that gives you a clear picture of who has paid on time and who settles late, which will help you determine to which customers you should extend trade credit.

How to improve and manage cash flow with trade credit insurance

Strong trade credit insurance remains the most reliable way to deal with trade credit risk and avoid cash flow issues.

When you take out a trade credit insurance policy, your insurer helps you assess the financial situation and creditworthiness of your existing and new clients. Then, a credit limit is defined for each customer, which is the maximum amount the insurer will indemnify if that customer fails to pay.

While you trade with your existing customers, the credit risk is covered up to the limit. Equipped with internal resources and a team of experts, your insurer informs you about the solvency of your customers to help you identify potential bad payers and makes adjustments to credit limits when economic conditions change.

Unfortunately, it is impossible to guarantee that 100% of your invoices will be paid – especially when your customers are abroad.

With trade credit insurance, you ensure that you are compensated quickly in the event of a bad debt. You’ll see an improved working capital ratio and dramatically reduce uncertainty regarding your cash inflows.

Trade credit insurance also allows you to substantially improve your DSO (Day Sales Outstanding), which is the average number of days it takes to recover a payment after a sale is made.

For you, it is a guarantee of being able to manage your operations and investments efficiently in the short and medium term, and to secure your growth.

Taking out a trade credit insurance policy is also a way of giving peace of mind to your finance partners. Your bankers or shareholders will be reassured about your company’s financial stability, and more inclined to guarantee its financing.

Trade credit insurance is an essential tool for building a balanced cash flow management policy. This solution allows you to protect and accelerate your commercial development while controlling the risks that trade credit poses to your cash flow. You then benefit from all the advantages of an efficient and resilient trade credit strategy.

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