A business investor called today to discuss a company he owned. “The company is growing, with new contracts coming from mostly outside the US”, he said. “The problem is that we don’t have enough working capital to support the growth and our lender isn’t giving us full availability on our line of credit either.” We went on to discuss the issues and potential solutions that trade credit insurance could provide.
Over half of my clients found me because of this same situation – the problem of accessing enough working capital through their line of credit. Fortunately, trade credit insurance offers a cost-effective way to access more financing.
How?
One of the biggest benefits of credit insurance is its ability to increase access to working capital. When a business insures its receivables, the credit insurance policy becomes an additional measure of security on the lender’s collateral and on the cash flow of the business. The result is that lenders can offer more financing for their borrower.
In my post, Back to the Basics: What is Trade Credit Insurance?, I explain how credit insurance works, how it’s structured and why most companies use it.
When?
There are five common situations where insuring receivables can help.
- Foreign sales: Whenever a company sells internationally, a lender has no way to perfect a lien on foreign accounts without going to a lot of trouble. Complying with the laws of the countries where the buyers are located is both expensive and difficult and results in foreign accounts being excluded from financing. With credit insurance, the risk of non-payment is removed and the lender can rely on the insurance in case of a payment default by the buyer/customer of their borrower. This additional repayment source allows them to include foreign accounts in the borrowing formula which increases the amount of working capital a borrower may access.
- Sales concentrations: A company is particularly vulnerable to devastating losses when a single industry or a few customers represent more than 20% of sales. The higher the concentration, the greater the risk. Lenders typically cap the amount available to borrow whenever these concentrations exist.
- Long terms of sale: In some industries and in international sales, customers demand long terms of sale. The longer the terms, the greater the chance that a buyer won’t pay. Lenders may not allow borrowing on sales made with longer terms unless they are insured.
- Custom inventory: Inventory financing is difficult for most lenders since they can’t always know the value of inventory and because liquidating it in the event of a foreclosure can be hard. This means that lenders either won’t finance inventory or they’ll reduce the advance rate (the percentage of inventory value eligible for financing) significantly. One of the most difficult kinds of inventory is custom inventory – the kind that is specially designed or made for the specs of one particular customer. Credit insurance can cover custom inventory making it possible for the lender to allow borrowing on that asset. For more on custom inventory and credit insurance, click here for my article written several years ago.
- Industry risk: When an industry is struggling, the risk of financing accounts goes up. An example today is the oil and gas industry. In 2009, the auto industry was a good example when most of the Tier One suppliers and two of the “Big Three” domestic auto makers were bankrupt. If lenders offer financing at all, it often comes with reduced advance rates or with additional collateral required. Credit insurance can help remove the risk, making the lender more comfortable.
Conclusion
Any time access to working capital financing is an issue for a credit-worthy company, credit insurance can help. My experience has been that the cost of a policy is very small when compared to the amount of cash it allows a lender to provide.
Have you found yourself or others in any of these situations? I’m happy to discuss the potential benefits! Leave a comment or email me with your thoughts.
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