Mitigating the risk of bad debts has become increasingly important
Amid the ongoing challenges of cost inflation and economic uncertainty, where a shortage of skilled labour, project delivery delays, and the burden of Covid-era loan repayments are putting a strain on balance sheets, a record number of construction firms and their supply chain partners have entered insolvency or administration in the past year. Indeed, according to a report by Begbies Traynor, a business recovery specialist, construction is the third worst-hit industry in the UK after property and support services. By the end of 2022, more than one in eight construction companies were in 'critical financial distress', with the building trade being the worst hit in the fourth quarter of 2023.
Trade Credit Insurance offers more than protection against unpaid invoices
These concerning findings only serve to underscore the importance of Trade Credit Insurance in protecting construction businesses from customers who cannot pay for goods or services provided on credit. However, as we'll see, Trade Credit Insurance not only safeguards against payment defaults but also strengthens a company's financial position, making it easier to secure financing for growth and development.
Preventing the ‘domino effect’
The ‘domino effect’ refers to a chain reaction of financial losses that occurs when one business defaults on payment, leading to subsequent failures in the supply chain. Suppliers who rely on that customer’s payments may also face financial strain.
Trade Credit Insurance ensures businesses receive a percentage of the outstanding amount owed (typically around 90%) even if their customers default. This prevents the domino effect from spreading to other suppliers and stakeholders and rippling through the supply chain. It achieves this by maintaining cash flow, allowing businesses to operate even if a major customer fails to pay. It also ensures that construction projects aren’t delayed due to non-payment of subcontractors and suppliers.
Access to financing
Trade credit insurance is a valuable tool for construction firms seeking financing. Banks and lenders view insured ‘accounts receivables’ – the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers – as more secure collateral. This perception can lead to better financing terms for construction projects. In short, businesses are more likely to access working capital and investment funds with Trade Credit Insurance in place.
Supporting business expansion
Trade credit insurance enables construction companies to offer competitive credit terms to new and existing customers, while trade credit insurers, in turn, provide extensive knowledge of companies, sectors and economic trends. This can boost confidence in exploring new markets, whether domestically or internationally, and expanding the customer base without the worry of financial setbacks. By insuring accounts receivables, businesses improve their working capital position. This liquidity boost supports investment in growth initiatives and expansion projects.
Reducing bad-debt reserves
Trade Credit Insurance not only helps businesses free up capital for other uses but also offers the financial relief of tax deductions on premiums, unlike bad debt reserves where money is simply set aside in case of non-recovery.
Integrating Trade Credit Insurance into risk management
Integrating trade credit insurance into risk management strategies is crucial for project managers in the construction sector. By aligning insurance coverage with the company’s risk appetite and strategic objectives, project managers can enhance financial stability and mitigate potential risks.
To implement a trade credit integration plan, a project manager should carry out the following steps:
- Conduct a comprehensive risk assessment to identify potential exposures related to accounts receivables.
- Understand the specific risks associated with customer insolvency, economic fluctuations, and payment defaults.
- Select an appropriate Trade Credit Insurance policy. (Your insurance broker can work with you to tailor the policy to align with the project’s unique needs, considering factors such as project size, customer base, and geographic scope.)
- Implement the chosen policy across the project.
- Regularly monitor accounts receivables and assess any changes in risk exposure.
- Adjust the policy as needed based on project dynamics.
- Incorporate Trade Credit Insurance into financial planning and reporting processes.
- Ensure that insurance coverage aligns with project budgets and financial goals.
- Include Trade Credit Insurance as part of risk reporting to stakeholders.
Ensuring your Trade Credit Insurance policy comes through when you need it
In light of the construction industry's insolvency crisis, Trade Credit Insurance coverage is a necessity for any company exposed to supply chain risks. Insurance policies come with complex and often specific disclosure requirements, claims conditions, notification requirements, and time limits. So, businesses must adhere to the terms of their Trade Credit Insurance coverage to avoid having their claims rejected on technical grounds.
It's crucial, therefore, to pay attention to the policy's disclosure requirements during inception, renewal, and any changes in your business's situation or scope. To avoid confusion, you should familiarise yourself with your insurer's notification requirements. This will help you identify what constitutes a 'circumstance' – broadly speaking, any situation or event that may lead to a future insurance claim – and inform you when to notify your insurer. Moreover, you should not lose sight of the deadline when considering disclosure and notification requirements. By being vigilant and adhering to the terms and conditions of the policy, you can ensure that your claims are processed smoothly.
Conclusion
Trade Credit Insurance is more than protection against unpaid debts – it's a strategic tool that can help ensure sustained growth, particularly in a market sensitive to economic fluctuations. Extending credit to customers can be a powerful incentive for attracting new business, but it also poses a risk to a business's financial health. By securing Trade Credit Insurance, companies can protect their cash flow and expand their operations, optimise their capital utilisation, secure favourable financing, and gain valuable market insights.
Contact us
If you'd like to discuss Trade Credit Insurance with one of our specialists, please call: 020 7280 3450 or email: enquiries@thecleargroup.com
