What is trade credit?
Between 80% and 90% of companies in the UK trade on credit terms (invoices), that means almost all business to business transactions. In essence, trade credit is when a customer pays for a product or service within a specified period rather than upfront. Usually, trade credit terms are either 30, 60 or 90 days, and no interest is accrued during this time. For many small businesses, trade credit is their only source of external finance.
What does trade credit have to do with the crisis?
Unfortunately, the current crisis is a good example of how trade credit poses a significant risk for businesses. Let's fast forward ten weeks or so, to when the lockdown is lifted. The shops, pubs and restaurants will reopen. People will go back to work. But doing business won't be the same.
Imagine you receive a large order from a customer who ordered regularly from you before the lockdown. You want to supply them, but they’re asking for 60 days credit. How do you know they can pay? Although that company was economically viable before the world stopped, is it now? Companies can file their accounts late and trade as technically insolvent under the new rules. More than likely, you’re far less able to absorb a loss than you were before the lockdown. They might drag you down with them.
Equally, if you were to need trade credit from your suppliers to get back on your feet, they’re unlikely to be comfortable giving it without protection in the current climate. So you’re going to need money upfront to start trading again.
What is trade credit insurance?
Companies insure their trade so that if a supplier goes bankrupt or can’t pay, their insurer will pay out and their cash flow won’t be affected. This is important because a bad debt (customer non-payment) can wreak havoc on a business’ bottom line. For example, the average business in the UK has a profit margin of 10%. A bad debt of just £15,000 would mean they’d have to make an extra £150,000 just to break even.
Until recently, trade credit insurance hasn’t had a lot of air time in the press. But it plays a vital role in oiling the world’s economic engine. It’s essential for giving companies the confidence to grow and enter new markets, even when supply chains span the globe.
Trade credit insurance & SMEs
Traditionally trade credit insurance has been a very corporate product but companies like Nimbla have simplified the product and made it accessible for lower turnover businesses. The ability to insure a single invoice means you can “pay-as-you-trade.” Nimbla also offers the ability to insure your whole turnover via direct debit.
Why do insurers need the Government to reinsure their risk?
The problem at the moment is that the crisis has raised risk levels, meaning that trade credit insurance limits are being reduced. Currently, insurance companies have only partial agency when it comes to decisions to cut limits. This is because they’re subject to regulation that requires them to stay robust enough to absorb losses. If they aren’t careful with their risk exposure in the crisis, it could endanger them too. But this still leaves many businesses depleted and overexposed, which could be disastrous.
That is, unless the Government temporarily underwrites the insurers’ risk, effectively acting as a reinsurer. A Government-backed scheme would allow the insurers to increase the amount of risk they can take. They would have to share their premiums with the Government but they would share the losses too.
Today you supply Jane’s Retail Outlet with goods to the value of £50k. The insurer might have cut that limit from £50k to £5k leaving you exposed to £45k.
Under a government scheme, that limit would be restored and you can continue to trade, safe in the knowledge that if your customer goes under they won’t drag you down with them.