Managing Trade Credit Risk
American companies have dramatically increased exports in recent years, largely due to the fact that the U.S. market has reached saturation and that 35% of the world’s consumer spending is now taking place in developing countries. Given these trends, aggressive American companies have no choice but to seek business overseas. But shipping goods and services overseas exposes a company to a host of new risks. One stands above the rest: credit risk.
For most U.S. companies, accounts receivable is among the largest assets. A default by a domestic customer could mean serious trouble, but there are generally legal means to recoup the loss. A default by a foreign customer, however, could spell disaster.
For that reason, many companies buy trade credit insurance. The concept is simple: if an overseas customer cannot — or will not — pay, the insured exporter still receives payment. Collecting becomes the insurer’s problem.
Today, nearly half of all European companies use credit insurance. By contrast, fewer than 10% of U.S. companies do, but inquiries have trended up in the past few years, with total global premium reaching close to $7.5 billion.
True, there are other ways to reduce credit risk, but they can seriously reduce an exporter’s competitiveness. The U.S. Export-Import Bank, for example, does offer trade credit protection. However, qualifying involves a number of rules and regulations regarding the types of shippers used and domestic content.
Letters of credit are another way to reduce credit risks. However, they require the participation of two banks, strict adherence to procedures and a new letter of credit for every transaction. Worse still, they tie up a customer’s cash until the transaction is complete. Rather than let their money lie idle while waiting for delivery, customers often go elsewhere.
Companies that frequently export goods should instead use trade credit insurance. It is simple, fast, competitively priced and tax deductible. And in addition to protecting accounts receivable, exporters find that trade credit insurance provides unexpected benefits.
For example, credit insurance can improve an exporter’s financial profile. With receivables insured, banks are more likely to extend credit and at a better rate. Savvy exporters also use trade credit insurance as a sales tool. With payment assured, they can offer buyers better terms. Trade credit insurance also enables exporters to accept larger orders. Some of the larger credit insurers can even assume an exporting company’s entire credit management and collections function.
Until recently, less than 1% of U.S. companies exported or conducted foreign operations. Most of them were huge multinationals. But now, small- and medium-sized businesses are venturing into foreign markets. And by doing so, many are discovering that insurance is not just a tool to mitigate risk but a way to access tomorrow’s markets.