Trade credit insurance protects small and mid-size businesses in the Philippines against the risk of loan default, which can happen due to delinquent invoices.
by Randolf Santos
Has your business attracted more clients over the last 12 months? While this brings an increase in profit, your risk exposure to unpaid invoices grows at the same time.
Small and mid-sized enterprises (SMEs) in the Philippines often overlook the importance of trade credit insurance to cover unpaid invoices from their clients or end buyers. Some business owners believe that revolving credit lines and bride financing loans already protect them from delinquent receivables. However, most of them fail to analyze the probability of defaulting on their debts because of non-paying customers.
Do You Have Too Many Pending Invoices?
On average, receivables comprise over 40% of SME assets, according to Benel Lagua, Development Bank of the Philippines executive vice-president. Out of these receivables, Lagua claims that one out of 10 usually becomes delinquent. This means that if you trade at 10% margin you have to sell 10 times more the value of your delinquent invoice just to make up for the loss.
Aside from non-payment, you have to think of the possibility of delayed liquidation of receivables which is also detrimental to your business. If you financed your invoice, your lender may have already imposed late payment fees for your inability to settle your short-term debt on time.
With these risks in mind, it is important to find ways to secure your receivables. These include selling your invoice via factoring entities, creating a liquid account solely for bad debt reserves, and trade credit insurance.
What Are the Benefits?
Trade credit insurance coverage for businesses guarantees payment of up to 90% of delinquent invoices. Your receivables become delinquent or unpaid when your clients file for bankruptcy or insolvency.It also protects you against protracted default or delayed payment, which manifests when a client can’t settle their financial obligations within six months from the original payment due date. These commercial risks are especially high when there is global recession or even industry developments that certain firms cannot adopt to
Aside from commercial risk, trade credit insured businesses also reduce their exposure to political risks that are beyond their clients’ control, such as terrorism or war, hence affecting their capacity to pay on time.
You can choose between export credit insurance and domestic credit insurance. The latter refers to coverage for businesses that only cater to buyers in the Philippines. Companies with overseas buyers and clients should consider adding export credit coverage to their insurance policies.
Which Companies Need Insurance?
Businesses in the construction, exporting, manufacturing and trading industries usually offer payment terms to their clients, and will therefore benefit from protection against buyer payment default. This does not only apply to local buyers, but especially to foreign ones. In fact, the effect of a payment default from a foreign client may be larger, given the difficulty of collecting payments offshore.
In the U.K., government data showed that several companies already declared insolvency in the second quarter of 2019, due to the growing political and commercial uncertainty from Brexit. With a 12% increase in the same period, the level of insolvencies has reached the highest since 2014.
SMEs in the Philippines should also look out for signs of growing political tension because of the U.S. and China trade war, and the Hong Kong recession, largely because of ongoing protest movements in the autonomous region.
How Much Does Insurance Cost?
Trade credit insurance in the country remains largely unused, especially by small businesses, despite a continually changing financial system. Luckily for SMEs, it’s now easier to find a trade credit insurer through online platforms. One of these, financial technology companies,Vesl, gives SMEs access to trade credit insurance paid on a per invoice basis, making it practical and affordable.
The actual cost of insurance depends on your buyer’s risk, with additional fees to have your buyers assessed. You can register on Vesl’s platform for free to start the process.
Trade credit insurance coverage may not recover 100% of your unpaid invoices, as it is a mitigation tool to recover some loss rather than losing everything. Insurance coverage not only prevents you from experiencing a slimmer profit margin. It also ensures that your creditworthiness for small business loans doesn’t take a negative hit. If you constantly engage in net 30, 60 or 90 payment terms, your risk exposure to defaulting buyers remains high even when you successfully expanded your customer base over the past year.