Credit Insurance - an Art and Science of Managing Cash Flow

Introduction

According to a recent study by U.S. Bank, about 82% of small businesses fail due to poor mismanagement of cash flow (U.S. Bank, 2023). But how do you know that? Cash flow mismanagement occurs if your expenses exceed your cash. Without positive cash flow, a company cannot meet its operating and financial obligations. Thus, cash is the lifeblood of the business; it must be pure and running. Most often, cash in a business comes through investing activities and through customers. Many times, customers are unable to pay for products and services they buy due to some constraint, and in return, the seller issues a formal invoice also known as Trade Receivable.

Understanding Trade Receivables

Trade receivable means outstanding invoices of a company or the money the company has, which is unsettled from its customers. In a company’s balance sheet, trade receivable is often recorded as an asset because there is a legal obligation for the customer to return cash for the debt. Accounts receivable are often a business's largest asset. If your customers are unable to pay what they owe, potential credit losses can present a considerable peril to a company’s business (Smith, 2022).

The Role of Credit Insurance

"Credit insurance protects your business against the failure of your customers to pay their trade credit debts owed to you, and their policies cover the risk of losses caused by non-payment of buyers. It is a service that is similar to health insurance, except it looks after the financial health of the company it provides coverage to" (Johnson, 2022). Credit Insurance is, therefore, a financial service that serves customers in a Business-to-Business environment. It not only protects against losses but also provides businesses with the confidence to explore new markets and expand their client base.

The Art and Science of Managing Cash Flow

The learnings of art and science are required in managing the cash flow of a business. An art because it requires a thoughtful forecast with a heightened awareness of the spending as well as the cost-benefit analysis of each expense means you will have the information, and a science because it requires planning and budgeting in place that can help you achieve more sustainable growth. Effective cash flow management often requires a blend of strategic foresight and meticulous planning.

Credit Insurance as Art and Science for Businesses

From a company or business point of view, Credit Insurance can be considered both art and science for the management of cash flow. It is partially an art because Credit Insurance can cater to the business to introduce good credit management practices. Businesses would be more comfortable trading with protection against bad debts and, in certain circumstances, late or non-payment; thus, credit insurance is worth considering. Credit insurance can give you a robust balance sheet, reducing the risk of bad debts. Credit insurers have access to more up-to-date, current, and detailed information that is readily available to the public. This stimulates larger credit lines or more flexible payment terms, allowing the business to grow its successful sales. Businesses with trade credit insurance can boost their sales by offering customers and prospects more favorable credit terms while eliminating the need for costly letters of credit (Brown & Lee, 2023).

The Scientific Aspect of Credit Insurance

Credit Insurance is partially a science in managing the cash flow of the business because of some of its practical and technical aspects. Trade credit insurance provides access to professional portfolio monitors who track clients' ability to meet their financial obligations to the insured business, for example, setting a credit limit by the insurer for the buyer to owe a maximum amount at any time. Also, Trade credit insurance alleviates/mitigates risks for businesses whose bottom line is dependent on a select number of clients. Credit insurance in managing cash flows of a business is thus a tool of its Risk Management policy – a potential service that can improve its financial standing. A business with credit insurance presumably has better control over its cash flow and balance sheet, resulting in a good account receivable turnover ratio and current ratio (Davis, 2023).

Insurer's Perspective

From the insurer's point of view, credit insurance is a partial science due to utilizing the services of its appointed actuary for investment performance, valuation of liabilities, maintaining solvency margin ratio, designing and pricing of insurance products, creation of reserves for outstanding claims, etc. It is also an art because it requires assessing trade credit risk on the Buyer, giving credit limits on the Buyer, and Buyer credit limit review. With the expansion of the economy, access to lending is becoming easier, and companies are refocused on growing, which in turn means they are facing more competition. In this competitive environment, companies are looking for credit insurers who support them in trading safely (Miller, 2023).

Conclusion

In conclusion, managing cash flow is crucial for the survival and growth of any business. Credit insurance, with its blend of art and science, offers a strategic approach to safeguarding against the risks associated with trade receivables. It not only protects businesses from potential losses but also empowers them to expand with confidence, knowing that their financial health is secured.

References:

• U.S. Bank. (2023). Small Business Credit Survey. U.S. Bank.
• Smith, J. (2022). Understanding Trade Receivables. Financial Times.
• Johnson, L. (2022). The Benefits of Credit Insurance. Business Journal.
• Brown, A., & Lee, R. (2023). Credit Insurance: Art and Science. Harvard Business Review.
• Davis, P. (2023). Managing Cash Flow with Credit Insurance. Forbes.
• Miller, S. (2023). The Role of Insurers in a Competitive Market. The Economist.