The effect of non-payment, whatever the cause, reduces cashflow and the ability to trade. And with the extremely tight credit conditions that exist at present, the banking system is often unwilling to support companies with additional funds to make up the deficit.
Add to that the fact that the cost of servicing existing credit facilities has increased in recent months and it becomes apparent why small businesses are particularly susceptible to the effects of the credit crunch, alongside defaulting customers, prompting many to face the threat of closure or consider shedding staff to manage costs and address the shortfall in revenue.
No business is immune from the current conditions, as demonstrated by the highly visible demise of major retailers such as Woolworths, MFI and Adams Childrenswear, as well as concerns over the construction sector and the automotive industry with their huge, dependent supply chains populated by small firms of all types and sizes.
‘Figures issued by the Association of British Insurers towards the end
of 2008 indicated that many smaller firms were turning to credit
insurance, often for the first time'
For those unfamiliar with trade credit insurance, the principle is quite simple. As the Atradius online glossary states, it is "commercial and political risk insurance against business-to-business payment default". Essentially, this means that if a customer should go out of business or default on payment for a range of other reasons, the policyholder will still be able to receive payment by claiming on the trade credit insurance policy.
Risk assessment
To ensure the process is both accurate and robust, every company with which the policyholder does business is given a credit limit based on a wide range of information drawn from international rating agencies, as well as additional supplementary data covering political, financial and other factors that might affect the individual credit limit.
Like most insurance, the individual customer credit limits are based on a detailed assessment of the level of risk. A low-risk company located in the UK with a good credit rating and stable balance sheet, for example, may be granted a high limit, while a new business start-up in Venezuela that has little or no trading history is unlikely to be covered as part of policy as it presents too high a risk to the policyholder.
The global credit crisis has highlighted the important role that trade credit insurance plays in stabilising trade. In 2008, as the lines of credit began to dry up, all trade credit insurers responded to the rapid change by reviewing their various credit limits to reflect the significant escalation of risk relating to defaults and insolvency. This resulted in large numbers of credit limits being reduced, realigned and, in some cases, withdrawn, in proportion to the risk environment.
Although the national media adopted a negative tone when reporting this topic, the number of limit cancellations and reductions initiated by Atradius, for example, amounted to only a small percentage of total credit limits. New business is being approved on a daily basis within Atradius; a feature that is likely to be true of most, if not all, trade credit insurers as they continue to provide support to businesses and help them trade safely in a challenging and changing business environment.
One of the key factors to emerge from the financial turmoil at the end of last year relating to trade credit limits was that communication achieved new levels of value and importance.
‘Buyers have become increasingly aware not only of the need to provide
up-to-date information but also the value and benefit of having access
to a credit rating when dealing with suppliers'
Sharing information
Buyers can help ongoing trade by sharing their most recent figures with the credit insurer, often in the form of management accounts, which are used to gauge whether a trade credit limit can be applied and can even lead to more flexible trading relationships with some suppliers, where cash trading was previously the only option available as a result of out-of-date information.
Information is absolutely critical to the welfare of ongoing trade as the original data on which initial decisions were made is almost certain to be out of date in an environment where credit conditions have been changing on an almost daily basis.
The economic downturn has brought an about-turn in the way information changes hands within the trade credit insurance industry. Historically, the insurer had always tried to obtain information directly from the buyer, often causing a significant level of concern as buyers immediately assumed that contact from their supplier's credit insurer was the harbinger of doom. As a result, the approach was often met with a reluctance, or even refusal, to co-operate.
Today, the situation is significantly different as buyers have become increasingly aware not only of the need to provide up-to-date information but also the value and benefit of having access to a credit rating when dealing with suppliers.
While most buyers are now much more responsive and provide regular good quality information when requested, the smarter buyers have developed much more open channels of communication with insurers.
For example, if the company has good news to tell, then they are feeding it through to the trade credit insurer as an interim update without being prompted. Although it's difficult to generalise, there are numerous examples of situations where companies have positively influenced a credit-rating decision by providing up-to-the minute information that has helped reinforce and demonstrate their stability.
The credit crunch has placed many businesses on the brink of failure and for many it has been trade credit insurance policies that have enabled them to continue trading. The role of trade credit insurers is to help businesses manage risk, concentrate on profitable sectors and to trade safely in a particularly challenging and changing business environment.
Shaun Purrington is regional director with Atradius UK and Ireland. For more information visit www.atradius.co.uk
