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The financial armour your business needs: trade credit insurance

The financial armour your business needs: trade credit insurance
16-10-24 / Sisanda Ndlovu

The financial armour your business needs: trade credit insurance, National Credit Regulator permits

Johannesburg - Trade credit insurance provides essential protection and peace of mind for businesses facing payment challenges. Trade credit insurance is not just about safeguarding against non-payment; it's about ensuring stability and optimising cash flow. In the event that a customer fails to pay, having an insurance policy in place allows businesses to recover and continue operations without severe financial strain.

The role of trade credit insurance lies in enhancing financing opportunities. Businesses with such insurance are often able to secure better financing terms from banks, improving their overall financial flexibility, explains Frank Knight, CEO of Debtsource.

The strategic advantages of trade credit insurance include risk management and detailed insights into trade risks. "Trade credit insurance helps businesses evaluate and manage their risk effectively. It provides a safety net, allowing companies to make informed decisions and maintain financial stability even in the face of unexpected challenges."

Knight emphasises the importance of having a robust cash flow management strategy. "Understanding your cash flow and ensuring your company can absorb potential payment defaults is critical. Trade credit insurance offers a valuable safety net, ensuring your business remains resilient."

Regular reviews and adherence to credit management practices is imperative. As Knight notes, "Effective credit management is crucial. This includes having robust credit policies, training staff, and ensuring compliance with the terms outlined in your credit insurance annexure."

Trade credit insurance can be a means of support to businesses which are exploring new markets and expanding their portfolios. "Trade credit insurance provides the confidence needed to take calculated risks and enter new markets. However, it's crucial for businesses to ensure their credit applications are thoroughly vetted and all necessary documents are in place."

Core to any credit management system is having valid credit application forms for each customer. For businesses facing pre-legal recovery situations without a credit application, Knight explains that while the insurance policy does not cover these costs, having a proper credit application in place is essential for claiming and mitigating potential losses. Knight says that while the absence of a credit application does not necessarily mean an insurer will repudiate a claim, having a properly signed and up-to-date application form is essential for minimising disputes and enforcing claims effectively. "Credit application forms help eliminate reasons for disputes and are crucial in the legal process. Without a valid application, enforcing claims can become more complicated and costly.

When it comes to recovery of costs and interest in the event a customer has not signed a credit application, Knight emphasises that capital and interest can be recovered though it is essential to have a formal agreement to charge interest on overdue accounts. "Without a signed credit agreement that permits interest charges, the customer is not legally obligated to pay interest. The National Credit Regulator permits a maximum interest rate of 2% per month for overdue accounts.

"Despite the costs, trade credit insurance is a worthwhile investment," states Knight. "It provides peace of mind and financial protection, ensuring that your claims are handled and losses mitigated."

He also highlights that while trade credit insurance typically covers a comprehensive debtor’s book, businesses can opt for selective coverage if desired. "Trade credit insurance can be tailored to cover all or specific debtors, depending on your needs."

However, trade credit insurance does not cover certain aspects such as CODs (Cash on Delivery), government or semi-government receivables, and fraud. Additionally, interest on overdue accounts is not covered by the insurance.

Knight details the distinction between domestic and export policies. "Domestic policies cover risks such as protracted default and insolvency within South Africa and the Southern African Development Community. Export policies, on the other hand, include additional protections against political risks such as foreign exchange issues and civil unrest," he says.

"Insurers are increasingly open to covering selective debtors or extending credit terms beyond the standard 30 to 60 days, up to 180 days or even longer in some European markets," Knight notes.

The cost of trade credit insurance is influenced by factors such as turnover, bad debt history and the specific type of coverage. "Selective debtor policies may have higher premiums due to concentrated risk, while comprehensive policies spread the risk across a wider debtor book," Knight adds.

Then there is the challenge in insuring new businesses. "Insurers typically require at least six to twelve months of operational history and financial documentation. For new businesses, providing a startup balance sheet and demonstrating capital investment can help in obtaining coverage."

The principle of limited discretion allows insurers to set guidelines for making insurance decisions up to a certain value. Insurers may vary in their approach: some offer higher discretion limits, while others impose stricter controls. This can affect one’s ability to manage coverage effectively and might influence the cost of insurance. Companies with robust credit management practices may negotiate higher limits of discretion, while those seeking broader coverage may face more stringent conditions.

Trade credit insurance generally covers risks like debtor insolvency, protracted default, and liquidation. However, specific risks and coverage details can vary by policy and insurer.

Consignment stock is typically excluded from trade credit insurance. This exclusion is due to the lack of control over the stock once delivered. Since the policyholder cannot manage or monitor the consignment stock closely, insurers view it as too risky to cover. Inconsistencies in stock management and the potential for future claims if the insurer withdraws coverage add to the complexity of insuring consignment stock.

Knight explains that disputes can arise for numerous reasons—whether it's goods not being delivered, defective products, counterclaims for consequential losses, or any other issues. When a dispute occurs, insurers typically require that you resolve the dispute or obtain a judgment before a claim can be validated. This often involves one of: negotiation; mediation; arbitration; or court action.

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