In the UK, nearly 1 in 7 SMEs fail to pay wages on time due to cash flow problems (source: Intuit Quickbooks, 2019).
Granting your client a 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 – thereby creating a cash flow gap.
In the US, 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 geared up 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 often can’t afford.
In any case, there are some essential best practices to manage your trade credit risk:
- Knowing who you’re dealing with is key: make sure you’ve evaluated your client’s creditworthiness before trading with a new customer. To go further, read the article on our US website on how to assess your customers' creditworthiness.
- Negotiate clear and appropriate payment terms.
- Setting up credit limits with your clients is another good move: the amount of credit you grant should not go above a certain 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.
In any case, you should always 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 knowledge.
A strong trade credit insurance remains the most reliable way to deal with trade credit risk and avoid cash flow issues.
First of all, your insurer helps you assess the financial situation and creditworthiness of your existing and new clients. Then, a credit limit is defined for each of your customer. The credit limit 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. Thanks to its internal resources and teams of experts, the insurer informs you about the solvency of your customers to help you identify potential bad payers and makes adjustment 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.
In this case, your trade credit insurer investigates and indemnifies you for the insured amount.
Commercial law is often complex and varies greatly from one country to another. Companies like Allianz Trade have in-depth knowledge of local situations and current legislation to effectively manage these potentially long recovery processes. Our country risk reports give you clues to manage these local risks and practices effectively.
Thanks to trade credit insurance, you ensure that you are compensated quickly in the event of a bad debt. Consequently, your working capital ratio improves and uncertainty regarding your cash inflows falls off dramatically.
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 the financial stability of your company, 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.