Combating credit risk – looking at export payment terms.

Today’s volatile political and economic landscape has highlighted credit risk as a critical boardroom issue.  Susan Ross of Aon Trade Credit discusses how insurance can help.

Businesses are continuing to seek opportunities to export in new markets.  It’s a competitive marketplace so it’s important to offer good commercial terms but the most flexible terms will bring additional risks to the exporter.  It is therefore essential that businesses protect their balance sheets and optimise working capital whilst minimising the impact of bad debt.

Letters of Credit

Many exporters ask for a letter of credit.  This bank payment mechanism is tried and tested and allows you to ‘sell and move on’, secure in the knowledge that, immediately after delivery, documents can be presented to the bank and payment drawn.   So long as the documentary requirements are workable and the bank is strong, letters of credit are low risk and solve a large part of your working capital needs. 

In some regions, such as North and West Africa, letter of credit payment is the norm for trade, and exporters would be wise to consider confirmation from a UK bank.  On the other hand, where foreign exchange is freely available and so long as your customer is creditworthy, requiring a letter of credit may make your offer uncompetitive.  The process of opening a letter of credit will be expensive for your customer, and has the potential to be a drain on his cash flow.  If you are asking for a letter of credit where your competition is offering open account terms, you may not win the bid.

Open credit with payment protection

Payment by simple invoice at 30 days, as UK traders will know, is low cost and flexible: quantities and values can be agreed at short notice, and there are not the additional documentary requirements associated with letters of credit.  However, open credit brings in the risk of insolvency, late payment and bad debt, and this is where credit insurance plays a key role in protecting against non payment.  Credit insurance will provide security, particularly when focusing on new and emerging market exports.  Credit insurance also offers a useful sounding board on creditworthiness, protects against non-payment and political risk and adds valuable security for receivables finance.

Export finance

Longer payment terms may be needed to allow for longer export transit times.  Your customer may also ask for terms to suit his business plan, and while 90 or 120 days might suit his cash flow, this will create a drain on your working capital.  It is worth investigating export finance, which comes in a number of forms including factoring, invoice finance, invoice discounting, and credit insurance backed receivables finance.  The key question is to be sure about whether the finance also comes with debt protection, and if not, that you have the opportunity to arrange credit insurance.

Political risk

Exporters to non-OECD countries, and indeed some that are closer to home, will also need to consider the political risks of export – in particular foreign exchange shortages and sanctions – and to arrange appropriate insurance for them.  The vulnerability of that country’s banking sector should also be a consideration.

Company procedures

Experienced exporters write procedures for assessment of customer creditworthiness: is the customer ‘good’ for the proposed value and terms of the credit to be extended?  A credit reference agency report will provide background information about ownership and may suggest a credit limit based on historic financials.  A credit insurer’s credit limit decision adds dynamic information and local knowledge, and the credit insurer has natural reason to ensure that its credit decisions are reliable – it will pay a claim in the event of bad debt.

Export payment terms

In conclusion, the commercial terms of an export, need to be attractive so that you win the deal, but not at the expense of taking undue risk or squeezing cashflow. Speak to a specialist trade credit insurance broker about the options for cash management and bad debt protection.  Exporting can be very rewarding but it needs to be a profitable experience.

Susan Ross is Client Director at Aon Trade Credit and Vice President of the British Exporters’ Association.  www.thehub-aon.co.uk

Susan Ross is Client Director at Aon Trade Credit and Vice President of the British Exporters’ Association. 
www.thehub-aon.co.uk