Credit insurance vs factoring and other alternatives

What are the alternatives to credit insurance and how effective are they?

Trade credit insurance is an effective tool for business intelligence and risk mitigation when trading on credit. But it is not the only option available to businesses. Some opt for solutions like factoring, or even self-insurance, however there may be considerable risks or costs attached to these approaches. This article will explore each option, and help you determine which of these is right for your business. 

Trade credit insurance   

Whole turnover credit insurance covers all of your credit trade transactions over the course of a year. You agree a credit limit and payment terms for each of your customers with your insurer. If an invoice becomes overdue, your insurer will reimburse you, usually up to 90% of the invoice value. Some credit insurers, including Atradius, additionally provide professional debt collection services. 

In addition to providing peace of mind that you will get paid and the knowledge that you will be paid by a certain date, trade credit insurance helps you with your credit management processes by providing you with up-to-date credit assessments on all of your customers and prospects. In addition to providing ongoing monitoring of your existing customers, this information can be invaluable when looking at expanding into new markets. 

Many of our policy holders tell us that in a bid to retain a good credit rating, their customers tend to pay them more promptly than other suppliers. Some of our policy holders also report using credit insurance to help them secure bank finance and even factoring. 

Factoring 

Factoring is when you sell unpaid invoices to a factor. It is primarily a tool to improve liquidity by creating a faster cash flow. It is the most widespread form of invoice financing and typically involves selling invoices for 70-80% of their value to a factoring company.  

There are two types of factoring, with and without repurchase. If you operate with buyback, you are required to buy back your invoices if they are not paid. If there is no buyback clause, then it is the factoring company that takes the risk of missed payments. 

Invoice Discounting  

Invoice discounting, sometimes called receivables financing, is when a bank or lender offers to give you an advance on the value of your invoice - often around 85% of the invoice's value. The advance is based on the bank's assessment of your customer's financial stability and the risk of trading in the customer's home country. The big difference between factoring and invoice discounting is that the bank does not get legal ownership of the invoices and is not responsible for recovering the payment. If a customer does not pay, you must still repay the money the bank has advanced. 

Guarantees 

Guarantees are an excellent choice for suppliers who want to secure a large one-off transaction in relatively well-developed markets, or when there is some uncertainty about your customer's creditworthiness. For your customers, the guarantee can be an alternative to prepayment and at the same time it can provide flexibility for both parties, as a guarantee can be linked to a single transaction or cover an ongoing collaboration.  

However, it can be a challenge to secure a guarantee, as banks often only issue them to companies that can demonstrate financial stability. In addition, you must make sure that the guarantor is financially stable. It is also worth mentioning that guarantees will not cover you if a payment is not made due to things like cancelled production licences, trade sanctions or other events that fall under the category of political risks. 

Letters of credit  

Letters of credit are a type of guarantee where a bank ensures a timely payment for the seller, while the customer must only pay when the goods have been received and the contract has been fulfilled. Letters of credit can be adapted and used when venturing into new markets. They are used especially in countries where banks are required to be involved in major import contracts.  

In the past, letters of credit were very common, but their popularity has been declining, as their usefulness is limited because you have to get a new one for every single transaction. This often makes them expensive and entails a high workload compared to credit insurance, where all transactions that fit within the credit limit are covered. 

Self-insurance 

‘Should I take the risk myself?’ is a question that many companies ask. Often, companies that choose to assess and take the credit risk themselves do so in the belief that it will save money or give them better control over the credit management processes. However, many will discover that the solution is not as budget friendly as it looks on paper. The work of self-assessing the credit risk of buyers can quickly become very resource intensive. What’s more it can make a business cash poor if their assets are tied up in uninsured sales with long payment terms.  

Accurate assessments of creditworthiness are difficult to achieve. They require a breadth and depth of knowledge and expertise that few companies have. Therefore, a company that takes up the challenge can risk either slowing down its own growth through overcautious credit ceilings or exposing the company to significant losses by not being restrictive enough. 

To summarise, each of the above tools has its function. We believe that credit insurance is the most versatile tool, as it removes the risk of trading on credit in a budget-friendly way, and at the same time offers a comprehensive package of debt collection service, security and advice that can help your company live out your growth potential.