Keep getting paid Featured

7:00pm EDT December 26, 2009

CFOs and other financial executives need to constantly balance the cost of doing business with the risk of doing business.

Jonathan Theders, president and chief operating officer of Clark-Theders Insurance Agency, says managing your accounts receivable is a large part of managing that balance.

“In a typical business, you’ve got several assets on your balance sheet,” Theders says. “You’ve got plant and inventory. You’ve got cash in the bank. But typically 40 to 70 percent of a company’s assets are the receivables that it holds on its balance sheet. And with that comes a lot of risk.”

Smart Business spoke with Theders about how you can keep the money rolling in by protecting your accounts receivable.

Why should businesses be concerned about the vulnerability of their accounts receivable?

In today’s economic environment, you have some unbelievable businesses going bankrupt. You never would have thought Kmart, Circuit City, Dana Corp. or GM would be struggling to this extent.

You look at all of these companies and ask, ‘How can these giants go bankrupt?’ Think not only of GM. Think of the people who supply to GM, the people who are waiting for payment from GM for their radios or their brakes or whatever component part they create.

The moment that firm goes bankrupt and you’ve got these huge outstanding accounts receivable, you may never see any of that money. You may see a percentage of it, but if GM is unable to pay its obligation to you, that negatively impacts your cash flow, earnings and capital. It can even put you out of business.

What can an executive do to control the volatility and vulnerability of a company’s accounts receivable?

Financial executives need to weigh the benefit of several options on how to mitigate that trade credit risk — how to control vulnerability of your accounts receivable.

There are several ways you can control it. You can self-insure it, which many people do. You can set up a bad debt fund, where you’re putting your dollars into this fund to help fund it. Or you can do what a lot of people do and just deal with it when it occurs.

Another option is factoring, where you send all of your accounts receivable to a third party. You have a third party billing it and, depending on the risk of the business, it may take 1 to 10 percent of that invoice as its fee for collecting the money. In that case, you’ve pushed the obligation off to another company for the collection, so you’ve controlled it to a degree, but at the same time, you’re cutting out 1 to 10 percent of your profit margin to do that.

How can trade credit insurance help?

Trade credit insurance is essentially a business insurance product that indemnifies the seller against any losses from the nonpayment of debt. When you insure accounts receivable for that business, if that business were to become insolvent, the insurance product would pay the debt from that insolvency.

The insurance company may have recovered part of that money behind the scenes, but what’s happening to you is you’re getting paid your money now.

In today’s market, where lenders are absolutely brutal to the companies that try to get loans, insuring your accounts receivable — which is oftentimes the largest asset on your balance sheet — with an insurance product gives the bank the comfort that there is protection. The bank can then lend more on that asset, or you may feel more secure in extending more credit to an existing customer, thereby increasing sales. Securing your receivables with a fully insured product can grow your business.

What does trade credit insurance cover?

Essentially, what you are insuring against is insolvency, bankruptcy and protracted or slow payments. In some instances, you might get paid but not in the 30-day term you were expecting. Maybe you’ll get paid a year from now.

Based on the policy you purchase, the insurance company could pay you to keep your business flowing, and then it will wait for that payment on the other end.

How can insurance help with the additional unpredictability of international accounts?

Banks are not likely to lend against international sales or international accounts receivable. It’s just too risky. But by insuring the international exposure, you can borrow against that asset because it’s protected.

By insuring that accounts receivable, an insurance company is going to step in and pay you your lost dollars and keep your business afloat. As many companies continue to globalize, they can expose themselves not only to lost receivables but also open themselves to very precarious political risks.

One factor you have to consider is world currencies. You could have a collapse of a currency, which causes a business failure overseas. You could have a physical war or insurrection that prevents your vendor from being able to perform your business function for you. You could even have the assets of that company confiscated.

Trade credit insurance can help you to grow your sales and profits, and because it allows you to extend larger, more competitive credit limits to companies, you can extend your payment term to make them feel more secure. It protects your cash flow and helps control the political risk when you deal with foreign countries.

Jonathan Theders, CPIA, is the president and chief operating officer of Clark-Theders Insurance Agency. Reach him at (513) 779-2800 or jtheders@ctia.com.