For any business, irrespective of size and industry, the two most important financial health indicators are Sales Ledger and Cash Flow. The main factor that governs the health of these indicators is the timely realisation of invoices.
Your business model cannot exist without credit, be it for sales or purchases. However, this credit must be restricted to a viable settlement cycle for your business model to sustain and grow. When this cycle breaks and the lag in payment realisation becomes stretched and frequent, your business’s financial future can be severely affected.
Breaks in the credit cycle can also impact your long-term plans to expand or diversify your business presence. A poorly managed credit system can directly and adversely affect your financial reliability and trustworthiness in the market, making it difficult for you to raise funds through borrowing.
Taking insurance for your credit management can save your business from unexpected failures and improve your financial credibility in the market.
Credit Insurance
Credit insurance is a type of insurance policy that provides financial protection against wholesalers, suppliers, and commercial customers becoming insolvent or failing to honour their credit. It also enables credit management by helping you keep track of your credit transactions and raising a flag on a potential bad debt.
A credit insurance policy can protect your business against two risks- the business risk of default or inability to pay and external risks like political disturbances. Note that, under credit insurance, you cannot raise a claim for situations involving the non-realisation of credit invoices due to factors like inter-party disputes or currency fluctuations.
Role of Credit Insurance in Business
If your business activities include deals with vendors, suppliers, wholesalers or manufacturers on credit, it is susceptible to the following five major risks:
Bad debts: Any business functioning on credit runs a continuous risk of irrecoverable debts. This could be due to either non-payment or delayed payment by the customer on account of the business or external factors.
Lack of market data: You may not always have access to information on the financial position of your buyer and the market data in general.
Inadequate access to funds: In an economic downturn, your business may not always have easy access to funding options. This lack of accessible loan facilities or business investments can hamper your plans for business growth and expansion.
Incorrect forecasts: Recurring credit defaults on loans or mortgages can impact your ability to make accurate business forecasts, including inventory, manufacturing or revenue forecasting, which leads to ineffective financial planning.
Venturing into an unknown market: Without access to market statistics and business conditions, it is difficult to place your trust in new buyers in a new market. This can affect your geographical diversification and expansion plans.
Importance of Borrowing in a Business
Borrowings play a significant role in your business for the following six reasons:
Growth: Loans can fulfil the additional capital requirements of your business, which can be used to fund new projects or increase existing production capacity. These funds ensure that your business has the impetus to survive and thrive in cut-throat competition.
Working Capital: You can also bridge the gap in your requirement of funds for day-to-day business operations. Also known as working capital, these funds can be used for timely payment to suppliers, daily operations, or other short-term obligations.
Cash Flow Management: Borrowed funds can optimise your cash flow when the inflow through sales is comparatively low. These funds can be used for payment of utilities or salary and wages until revenue generation is stabilised.
Investments: Instead of using cash and decreasing liquidity, you can use borrowed funds to acquire assets and build investments like plant or machinery, heavy equipment, or funding research and development.
Competitive Edge: If your business operates in an extremely competitive environment, it is important to stay ahead to relevant. The funds obtained through borrowing can allow your business to swiftly act on any business opportunity. Right from acquiring a competitor to purchasing in bulk, borrowing can help you to capitalise on opportunities.
Tax Benefit: The interest proportion on these borrowings is a tax-deductible expense that reduces your overall tax burden. Thus, borrowings have the dual benefit of saving up your liquidity and your taxes.
Does Credit Insurance Help in Borrowing at Lower Rates?
While we have discussed the numerous benefits that borrowing can offer a business, the cost of borrowing must be controlled to manage your overall financial position. This is because, if the cost of borrowing exceeds the return on money deployed, it may further harm your financial position. Credit insurance can keep the cost of your borrowing under control.
Banks and financial institutions are often more accommodating and flexible with companies with secured debts. Here are some of the factors that influence the lender’s decision to lend at a comparatively lower rate:
Low Credit Risk: Credit insurance mitigates the risk of non-payment due to customer defaults or insolvencies, reducing your business's overall risk. This improves the risk profile of your business, enhancing the lender’s confidence in your ability to grow your business and honour your commitments.
Improved Financial Standing: When you proactively take credit insurance for your business, it represents your willingness to avert risks and ensure an increase in your cash flows. This goal of improving financial position by minimising defaults is one of the key factors that provides confidence to the lenders to provide funds on more lenient terms.
Availability of More Options: With a positive risk profile and attractive financial standing in the market, your business has access to more fundraising options than ordinarily available. Therefore, as a general market rule, when the supply is comparatively high, the price is bound to fall. The availability of many options allows you to raise funds at better terms and lower rates.
Bargaining Power: If your business risk is secured with credit insurance, you have the leverage to borrow at the terms and rates that are more favourable to you.
By offering financial protection, credit insurance can be a game-changer for your business financing prospects. It can give you an edge over competitors by opening the gates to better and cheaper borrowing options.
