Tips on how to manage risks in your debtor book

By Barbara Cestaro MICM*

“If you’re not a risk taker you should get the hell out of business.”

– Ray Kroc

Barbara Cestaro MICM

Ray Kroc was a milkshake machine salesman when he bumped into Richard and Maurice McDonald (you know where this is going now). He was incredibly impressed at how they ran their burger restaurant in California. He took a risk, negotiated a franchise agreement with the brothers, and the rest is fast food history.

Not every business can achieve what McDonald’s has but every business comes with some risk. One of the roles we play in our business is risk management. Formally or informally. Consciously or unconsciously.

Risk management is a complete profession in its own right. When studied it is traditionally split into 3 categories: risk avoidance, risk mitigation and risk transfer.

Risk avoidance is straight forward. But it isn’t particularly rewarding and it’s a questionable way to do business. If you don’t want to risk clients not paying invoices, make them pay for everything up front. Picture how that would affect most businesses. No defaults. Yey! But also, no clients.

Risk transfer is almost as straightforward. Transferring your risk to an insurance company is centuries old with early insurance houses being established in the late 1600s. Types of insurance however have been uncovered by archaeologists as far back as the First Babylonian Empire (and it was boring then too). We know that insurance comes at a premium and we are willing to pay that rather than risk the much, much larger potential loss. We make a decision, premium versus potential loss.

Risk mitigation however is a bit of a dark art. How do we take intelligent actions to lower the risk to our business?

The trade credit policy has been traditionally seen as ‘whole

“The trade credit policy has been traditionally seen as ‘whole turnover risk transfer’ option only, but there are many more flexible options now, which allows the transfer of only part of the risk and managing the rest.”

turnover risk transfer’ option only, but there are many more flexible options now, which allows the transfer of only part of the risk and managing the rest. Insurers rely on existing Credit Management procedures, basically outsourcing the risk underwriting to the client up to a certain pre-agreed level. Only exposures above that will require the insurer’s assessment and monitoring, therefore minimising the administration of the policy and improving the overall risk acceptance. The higher the risk share you are willing to take, the higher the value of the discretionary limit.

Although a trade credit insurance policy is a vehicle for risk transfer, the average policy also provides guidance on how to manage risks in your debtor book.

1. The credit and sales process should start at the same time.

Some trade credit policies don’t allow for retrospective credit limits, so, make sure you’ve done your checks in advance of shipping goods, completing the service, or signing the contract. Simple first checks could be applying for a credit limit and/or ordering a credit report if you use a discretionary limit.

If there are red flags at this stage, then you could be saving the business money in the long run but also saving time and effort up front. It might not always be a hard no but at least you can agree shorter payment terms, a smaller order, or a larger deposit. Having the information means you can manage the risk with eyes wide open and, if you have a policy, balance uninsured and insured exposures. ➤

“The trade credit policy has been traditionally seen as ‘whole turnover risk transfer’ option only, but there are many more flexible options now, which allows the transfer of only part of the risk and managing the rest.”

“Insurers rely on existing Credit Management procedures, basically outsourcing the risk underwriting to the client up to a certain pre-agreed level. Only exposures above that will require the insurer’s assessment and monitoring, therefore minimising the administration of the policy and improving the overall risk acceptance.”

2. Invoice regularly. Most trade credit insurance policies have a “maximum invoicing period”, the longest time that can elapse after shipment that the invoice can be issued.

This stops credit terms being artificially extended and it also avoids your clients dictating when you send the bill. Even if there is a dispute about delivery condition, quality of work or any other reason.

Send the invoice. Start the clock.

3. Don’t blur the boundaries.

Salespeople love to do a deal don’t they!? And sometimes they’ll offer payment terms that push the envelope just to hit their bonus (sorry salespeople but you know I’m right). Trade credit policies have maximum payment terms embedded to stop this happening. Max terms of, for example, 60 days in a policy give the front end of the business flexibility but keep a bit of control at the back end.

When your broker is helping negotiate your policy terms, they will want to understand the typical terms in your business and your market, so the policy is right for you.

If you need payment terms outside of the norm then ask

why. Why is this a special case? How will this affect us?

4. Take every late payment

seriously. Most trade credit policies require that these are notified even if there is a dispute or an admin error.

Why? Because a business could suddenly be having disputes with 5 other policy holders, and if this happens, only the insurers would have the full picture, not the individual suppliers. Following the policy requirements means that you take all the emotion out of the decision on whether to agree an extension or a payment plan.

Yes, you can empathise with your client. Yes, you can believe your client. But if you make no exceptions then you reduce your risk. At worst you force an open conversation about the debt. Trade credit insurers have been tweaking this framework over decades with hundreds of thousands of clients across the world. Nothing is perfect, and there will always be surprises but that is what risk mitigation is all about. Your business can take an acceptable level of risk knowing that it has done as much as it can to manage the downside whist still trading, growing and being profitable.

So, work with your broker and insurer today. Be a risk taker. Be like Ray.

*Barbara Cestaro MICM Client Manager Aon Credit Solutions E: barbara.cestaro@aon.com www.aon.com

© 2022 Aon Risk Services Australia Limited ABN 17 000 434 720 (Aon). The information provided in this document is current as at the date of publication and subject to any qualifications expressed. Whilst Aon has taken care in the production of this document and the information contained herein has been obtained from sources that Aon believes to be reliable, Aon does not make any representation as to the accuracy of information received from third parties and is unable to accept liability for any loss incurred by anyone who relies on it. The information contained herein is intended to provide general insurance related information only. It is not intended to be comprehensive, nor should it under any circumstances, be construed as constituting legal or professional advice. You should seek independent legal or other professional advice before acting or relying on the content of this information. Aon will not be responsible for any loss, damage, cost or expense you or anyone else incurs in reliance on or use of any information in this publication.

“Nothing is perfect, and there will always be surprises but that is what risk mitigation is all about. Your business can take an acceptable level of risk knowing that it has done as much as it can to manage the downside whist still trading, growing and being profitable.”