It’s all about credit risk. If you sell on open credit to your customers, there will be times when you are concerned about repayment. The first question you should ask yourself is: Why would I sell on open credit to a questionable credit risk? The second is: Is it worth it?
It you are funded by a recourse factor, you retain the credit risk of non-payment. In the event your customer goes bust or just doesn’t pay, you are ultimately responsible for any funds advanced to you by the factoring company. How can you protect your company against a bad credit?
One option is trade credit insurance which insures manufacturers, traders and providers of services against the risk that their buyer does not pay (after bankruptcy or insolvency) or pays very late. The trade credit insurance premium will be based primarily on the credit profile of the customers you are insuring against. The trade credit insurance policy will pay out a percentage of the outstanding debt. This percentage usually ranges from 75% to 95% of the invoice amount, but may be higher or lower depending on the type of cover that was purchased.
What kind of risks are insured? Trade credit insurance insures against the risk that a buyer does not pay. It can also cover the risk that a buyer pays very late. A buyer will not pay after he has been declared bankrupt, insolvent, or a similar legal status. Similarly buyers sometimes opt for a bankruptcy protection arrangement, which allows them to delay payments for an extended period. Both instances are covered under a trade credit insurance policy. Trade credit insurance policies can include a wider range of cover, depending on the circumstances. Some policies consider a delay in payment also to be an insolvency (so-called protracted default cover). If a buyer does not pay, the trade credit insurance policy will pay out a percentage of the outstanding debt. This percentage usually ranges from 75% to 95% of the invoice amount, but may be higher or lower depending on the type of cover that was purchased.
Thus, if you are factoring with recourse and you don’t want to be on the hook for all the credit risk, trade credit insurance may be an option.