Uncertainty is a constant factor in our lives. In fact, we encounter unprecedented levels of uncertainty in many areas, such as weather conditions or the outcome of sports events. Three years ago, the world experienced a terrifying pandemic that had far-reaching effects, including the collapse of numerous businesses worldwide.
The truth is that credit plays a crucial role in any business, either making or breaking it. It is actually common practice to conduct business transactions on credit, whether it involves purchasing input materials, selling finished products, or providing services, with settlement cycles varying across industries.
Let us consider a scenario where a small business owner sells products worth INR 15 lakhs on credit to a major buyer, with a settlement cycle of T+30. Unfortunately, due to unforeseen circumstances, the buyer becomes insolvent, leading to the closure of their business. The amount involved is significant for the small business owner, and the inability to recover it results in the collapse of their own business. This is not a fictional situation rather, many businesses in the country suffered exactly such a tragic outcome.
While the dependence on credit cannot be eliminated or significantly reduced due to factors like business growth, expansion, or managing currency fluctuations, the associated risks can definitely be mitigated through credit insurance.
Understanding Credit Insurance
Credit insurance provides financial protection against the insolvency or failure of wholesalers, suppliers, and commercial customers to honor their credit obligations. This policy reduces the risk of financial loss for your business and offers credit management support by monitoring credit transactions and flagging potential bad debts. Thus, a credit insurance policy is crucial for planning your business's finances.
This policy also acts as a financial safeguard if you are availing a loan or mortgage facility in your personal capacity, protecting you from the risk of non-payment in the event of death, injury, or unemployment.
Risks Covered
A typical credit insurance policy covers the following risks:
Business Risks:
Prolonged default: When your buyer fails to pay the debt receivables within the agreed settlement cycle.
Inability to pay: When the buyer is unable to pay the debt due to insolvency, death, or permanent disability.
External Risks:
Political unrest
War or rebellion
Disagreements in trade policies or trade restrictions
Natural calamities
Local regulations in the buyer's country
Under a trade credit insurance policy, the insurer will pay an agreed percentage of the invoice if your customer fails to pay due to any of the aforementioned factors. However, there are certain circumstances under which a claim cannot be raised, including trade disputes between buyer and seller resulting in payment withholding, risk arising from nuclear or radioactive war, amounts due from government entities or departments, accrual of interest on unpaid amounts, and currency fluctuations.
Advantages of Credit Insurance
Here are the top six benefits of credit insurance:
Reducing Bad Debts: Credit insurance protects your business against non-payment or delayed payment by buyers, safeguarding against losses caused by business or external risks. This ensures uninterrupted cash flows and helps maintain strong financial records.
Risk Management: Insurance providers have access to extensive market data, allowing them to assess the creditworthiness and financial history of potential customers. This helps businesses make informed decisions regarding extending credit lines.
Better Financing Options: Trade credit insurance builds trust with banks, financial institutions, and private lenders. The insurance policy demonstrates reduced trade credit risk, improving your creditworthiness and increasing your ability to secure more funds for business expansion or investment purposes.
Financial Management: Insurance providers monitor expected cash inflows and potential default instances, leading to better revenue forecasts and informed decisions regarding inventory and production planning.
New Avenues: With insurance support, you can explore new customers and territories that were previously considered risky, fostering market diversification and business expansion.
Strong Financial Records and Planning: By obtaining credit insurance, you can reduce credit risks, ensure cash flow stability, and support your expansion plans. Taking control of these essential business parameters ensures strong financial records and successful financial planning.
To apply for credit insurance, approach an insurance provider that suits your requirements. They will assess your business metrics, claims history, loans, investments, and industry trends. Based on this data, the insurer will determine the premium, maximum credit limit, and risk coverage. The insurance provider will also have regular access to your financials and transaction history to monitor potential defaults that may impact your financial plans.
Conclusion
By obtaining credit insurance, you can minimize the impact of unexpected business shutdowns and ensure the stability of your debt payments and financial standing. This insurance is particularly beneficial for small and medium-sized enterprises, as delayed invoice realization can result in longer working capital cycles, smaller margins, and liquidity issues.
Regardless of business size, every company is vulnerable to slowdowns or closure due to poor financial planning, which, in turn, is heavily influenced by the credit position. At the end of the day, trade credit insurance not only strengthens your financial resilience but also provides unshakeable faith and assurance.
