The COVID-19 pandemic has had tangible impacts on all economic operators. Some sectors have been hit badly, others less severely, and of course there are sectors that have emerged as winners from the pandemic and the resultant crisis. Naturally, no business organisation can isolate itself completely from national economic or global real economic processes, but the extent to which a given company is affected by the pandemic largely depends on the situation it was in when the crisis reared its head. For example, the company’s capital position, its outstanding receivables, what reserves it had, how affected its customers and suppliers are, and of course, how quickly and extensively the management managed to adapt to the new conditions.
Under such circumstances it is extremely important to monitor customer risk regularly, since non-payment not only jeopardises the company’s liquidity, it is also a threat to its successful operation in many cases.
There are two tried-and-tested methods for managing customer risk: credit insurance and factoring.
Credit insurance
Credit insurance is a complex service. It can cover all clients, thereby ensuring the creation of a balanced portfolio, including clients performing both better and worse, and those more likely to perform or not perform. It can also be taken out for certain partners only, if the company deems this necessary based on the information available.
Credit insurers carry out their own risk analysis procedures for all companies in their credit insurance portfolio, and only enters into a contract with the given partner when the likelihood of an insurance event happening is sufficiently low at the time of the rating, or when the risk premium associated with non-payment can be rolled into the insurance premium. The rating also determines what security the given partner must provide to take out the credit insurance.
If an insured partner does not meet its payment obligation on time, this in itself does not create a loss claim since it must be preceded by attempts to collect the receivable. The credit insurance service may include collecting receivables as well.
An insurance event occurs if the reasonable attempts set forth in the credit insurance contract to collect the receivables are unsuccessful; the company then receives the compensation due based on the credit insurance besides the security for the given partner.
Since non-payment is the insurance event, it is easy to see that the company cannot gain access to the value of the invoices before they fall due, so credit insurance is not able to improve the company’s liquidity position.
Factoring
Alongside credit insurance there is another effective method for managing customer risk: factoring. In contrast to credit insurance, factoring can also improve a company’s liquidity position, it is essentially a transfer of receivables. However, it is important to proceed carefully and choose a factoring contract that meets your needs. If you do not want to continue bearing the non-payment risk of a customer after factoring, it is important to opt for non-recourse factoring. In this case, the factor takes on the risk of non-payment, while with full-recourse factoring, if the partner ultimately does not pay, the factor collects its receivable from you.
It is also important whether the factor settles the value of the receivable at the start of the factoring or when the receivable is paid. In the first instance the factoring can substantially improve your liquidity position, while in the latter case it only manages the risk of non-payment.
Other procedures
With partners where there are clearly problems with non-payment, there is a good chance that neither factoring nor credit insurance will help.
Going down other paths is justified in this context. First of all, it is worth reviewing the size of credit facility of the given partner, or introducing one if they do not have such an option. In more serious cases it may be justified to suspend sales on deferred payment terms.
Do not forget that a company is exposed not only to the non-payment of customers, but also that of suppliers. In this case, if a company’s activity largely depends on one supplier, it is worthwhile looking into alternative procurement sources, and possibly diversifying purchases.
Since many different factors have to be weighed up when regularly monitoring and managing client risk, it is advisable to consider involving an expert. Feel free to contact the professionals at WTS Klient Hungary, who, as consultants, will be happy to support you with issues surrounding credit insurance, factoring, or other methods of managing customer risk.
