A client of mine was recently talking to me about one of their customers who had been covered under their credit insurance policy, but coverage was suddenly cancelled due to negative financial information that came to light.
According to my client, they have been selling to their customer for the past ten years, on 90-day terms, and payments have always come in like clockwork. Over the years, this customer has grown to occupy about 20% of my client’s annual sales.
Before the holiday season, the customer’s president called my client and requested that terms be extended to 100 days. Not sure exactly how to respond, my client called me and asked me what I thought of the situation. Perhaps this request reflects some financial downturn that the customer is currently experiencing.
To begin, extending credit to a commercial client that cannot be covered under trade credit insurance is a decision that requires careful consideration of both risks and potential rewards. As many of us credit professionals already know, trade credit insurance typically serves as a safeguard for businesses, protecting against losses from non-payment. The absence or rejection of such insurance coverage may indicate that a commercial client poses a higher risk, whether due to financial instability, poor payment history, or operating in a volatile industry. However, there are situations were extending credit, as well as payment terms, even without insurance, may be a strategic decision.
Reasons Against Extending Credit
The primary reason to avoid extending credit and/or payment terms, is the customer’s perceived financial instability. Trade credit insurers have access to extensive financial data and sophisticated risk assessment tools. A rejection often signals concerns about the customer’s ability to repay debts, such as poor payment history, declining revenue, or high debt levels. Ignoring these red flags could expose one’s business to substantial financial losses if the customer defaults.
In addition, extending credit without insurance coverage could strain my client’s cash flow and its own viability in the event of a payment default, since their customer occupies 20% of their annual sales.
Reasons For Extending Credit
On the other hand, rejecting the extension of terms might mean losing a valuable business opportunity. If the customer has a reasonable explanation for the insurance rejection, such as a temporary setback or an issue unrelated to their core operations, it might still be worth extending the terms. In such cases, the customer might be willing to pay higher margins or provide other concessions to secure your trust.
Another consideration is the potential for strengthening customer relationships. If my client offers the additional ten days, the customer may view this as deepening their business relationship while they try to recover. However, this must be weighed carefully against the risks.
My advice
After careful consideration and discussion with my client, it was decided to introduce a factoring company to the customer as an overall strategy to support the customer’s extended credit and cash flow needs. In short, here are few benefits to factoring receivables:
Improved Cash Flow – Factoring provides immediate access to cash that would otherwise be tied up in accounts receivable. This can be particularly beneficial for businesses, like my client’s, with long payment terms or slow-paying customers. The improved liquidity allows companies to meet payroll, pay suppliers, and cover other operational expenses without waiting for customer payments.
Easier Access to Financing – Factoring can be easier to obtain than traditional bank loans or lines of credit. Since the factoring company evaluates the creditworthiness of the paying entity rather than one’s business, it can be an excellent financing option for any business that is experiencing a cash flow crunch.
Strengthened Supplier Relationships – In the case of my client, the immediate cash flow from factoring would allow their customer to pay them much sooner than the existing 90-day terms, which will also improve their relationship.
So, in essence:
Extending credit, let alone payment terms, to a customer that was rejected for trade credit insurance coverage involves an understanding of why the insurance was cancelled (or denied) and searching for alternatives that will still improve credit worthiness, increase cash flow, and deepen customer relationships.
Your thoughts and comments (nseiverd@cmiweb.com) are most welcome!
Nancy Seiverd, President
CMI Credit Mediators, Inc.
All Rights Reserved
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