The outbreak of the coronavirus pandemic has drawn the world’s attention yet again to what should have become evident well before now: the fragility of our increasingly inflexible global supply chains.
The automotive sector, for example, has been brought to its knees by reduced microchip deliveries, as have many other industries. Nothing could be more important at the present moment than defeating the pandemic, yet we’re still facing supply-chain-driven shortages of vaccines, personal protective equipment, and other medical supplies.
The logistical challenges in today’s global supply chains are compounded by competing market, cultural, and political forces. Pressures to boost domestic jobs are driving businesses and governments to try and re-shore manufacturing when the most economic and efficient sourcing may remain abroad — in countries with which they have interdependent relationships, but are simultaneously engaged in bitter trade disputes.
Uncertainty reigns as we move through 2021. Will nations shift to domestic supply chains? Continue doing business as usual? Move production to new third-country markets? Will suppliers an or buyers evolve past just-in-time inventories that have become wound down so tightly that supply chains have lost all flexibility to deal with the unexpected?
Companies looking to survive and flourish in the meantime, while helping their suppliers and customers to do the same, can start by understanding the essential role of trade credit in managing supply chains.
Demand for trade credit has evolved since last March, and will not return to pre-2020 norms in 2021. Maybe not ever. Customers have less access to working capital from banks and other financing sources, so they’re turning to their suppliers or higher credit limits and longer payment terms. At the same time, customers are getting paid more slowly by their customers, operating remotely or with social distancing, and encountering ongoing change and uncertainty — all while trying to hang in there long enough to participate in the eventual recovery.
Beyond reacting to customers’ demands for credit, suppliers need to recognize the proactive reasons for offering competitive payment terms and trade credit’s impact on supply chains. Extending more credit enables suppliers to produce or purchase more efficient quantities, strengthens manufacturing throughput, gets customers to stock more inventory, stages products nearer to end-users, and helps to maintain market shares for when the economy comes roaring back.
Risk Management Challenges
When you extend more credit and longer terms, however, what happens if you don’t get paid? Nonpayment risks have always existed, of course, but the downsides have become more acute in the time of COVID-19 because of customers’ bankruptcies, cash flow and working capital issues, excess leverage, quarantines and lockdowns, and other problems caused by the pandemic.
Another challenge is the risk to suppliers’ working capital. Ninety days is the new net 30. On top of that, customers may be paying slow, stretching remittances even further. Unless a company has a lot of cash in reserve, it faces the challenge of filling new orders while continuing to pay labor and material expenses.
At the same time as suppliers are extending more credit, accounts receivable have become more difficult to finance. Banks and other lenders have their own supply chains of capital, and face risk-management challenges to monetizing receivables that present with longer terms, slow payments, and risk concentrations — especially amid widespread uncertainty and during a recession.
Businesses can rise to credit demand in the following ways:
Sources of Credit Information
It may not be easy, or even commercially viable, to reevaluate the creditworthiness of established customers. To the extent this can be done, however, it’s important to take a hard look again now. Salespeople and account managers might push back, not without good reason, against approaching longstanding customers for updated financial information. Suppliers need to walk the line between the imperative to reexamine payment risks and preserve existing business relationships.
Sources of useful credit information include trade references from customers’ other suppliers (the best, of course, being one’s own ledger experience), customers’ year-end financial statements (hopefully available earlier in 2021 than they were last year), interim operating results (at least quarterly), credit bureau reports (beware “coronavirus credit score” algorithms; nobody can predict outcomes yet), industry creditor groups, trade associations, online information, virtual site visits, and video dialogues with customers.
Trade credit insurance protects suppliers’ accounts receivable against virtually all nonpayment risks. If a customer covered under a policy defaults, and the debt can’t be collected, an insured supplier can file a claim and get the loss indemnified.
All of a supplier’s insurable sales can be covered under one policy. A credit limit may be underwritten for each customer or, alternatively, a policy will insure the credit decisions a supplier makes based on its own experience. Alternatively, a supplier can apply for a receivables insurance policy covering only its largest customers. Or it can be even more selective, as long as the insurable sales represent a reasonable spread of risk. Policies covering a single customer are less common, but might be feasible in some cases for a very creditworthy debtor.
Premiums are based on the terms a supplier extends, the spread of risk, and past experience. The cost is low, typically a fraction of a percent of your covered sales volume. Whether or not suppliers pass this incremental expense to their customers, the price is insignificant compared to the business opportunities engendered by managing nonpayment risks while extending competitive credit terms.
Credit Insurance in COVID-Time
Historically, suppliers in other parts of the world have used credit insurance more extensively than their counterparts in the U.S., but demand for the coverage here has been surging since the outbreak of the pandemic. At the same time, underwriting capacity has tightened and credit insurance has become a seller’s market. Insurance companies are still offering quotes, but it’s unknown how long they’ll continue issuing new policies.
Buying a credit insurance policy now enables suppliers not only to manage their risks but also to keep selling in this uncertain new normal, grow business with more competitive payment terms, increase profitability, and enhance borrowing capacity (by designating a lender as the policy’s assignee or loss payee).
The best way to obtain credit insurance is by applying for coverage on a reasonable spread of risk rather than cherry-picking. Covering all receivables provides the most comprehensive risk management anyway, since nobody knows in advance which customers might default. It’s also a good idea to provide a cover memo with the application, describing the impacts of COVID-19 on the applicant’s own supply chain.
In policy quotations, expect to see higher deductibles and new requirements to monitor customers’ creditworthiness. Insurers are seeking to share the risk, not take all of it on themselves. Premiums are increasing across the board, but rates remain low compared with the benefits of credit insurance.
Insurance companies paid a lot of trade credit claims in the wake of the 2008-2009 recession. Since then, claim volumes have remained relatively level, but now losses are climbing, and claim filings are projected to increase in the next three to six months. Even if this won’t be their favorite year, credit insurance companies are going to need to come through again for their policyholders in 2021.
Gary Mendell is president of Meridian Finance Group.
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