Protecting and Leveraging Your Accounts Receivable in a Time of Uncertainty

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With countless businesses having either temporarily closed or significantly reduced operations during the coronavirus pandemic, many businesses are rightfully concerned about their ability to meet obligations, and, relatedly, the prospect of their customers being unable to pay their bills. While legislation enacted in response to the pandemic as well as other government-sponsored resources for small businesses have been extensively covered, in this unprecedented business environment, your business should consider all options available to it to ensure its continued success.

Indeed, an oft-overlooked resource lies within your company: your accounts receivable. For many businesses, this is the most important asset on the balance sheet. This article provides an overview of options for protecting and leveraging your accounts receivables to ensure your company successfully navigates this uncertain business environment. 

Trade Credit Insurance

Trade credit insurance (also known as accounts receivable insurance) is an insurance policy that covers financial losses due to unpaid debt. Specifically, it covers the risk of unpaid invoices due to default, insolvency, or bankruptcy of a customer. In other words, it is insurance against the risk of nonpayment of customer invoices.

There are numerous benefits of purchasing a trade credit insurance policy. Among other things, it can improve cash flow, it effectively outsources debt collection efforts, it can allow you to obtain better financing and lending rates since your company can assure a lender it will not have covenant issues if there is default by a customer, and it can free up reserve capital set aside to protect against customer nonpayment. Additionally, it can give your business flexibility in that you can extend credit to customers or lengthen payment terms without taking on additional balance sheet risk.

Most trade credit insurers provide insureds the option to insure all or a specific portion of their accounts receivable. Companies can purchase a customized policy that only covers certain accounts, such as high-dollar or high-risk accounts.

A policy on domestic receivables typically ranges between one-tenth of one percent of sales to four-tenths of one percent of sales. The premium will depend on the risk profile of the customers and the business sector. 

Accounts Receivable Financing

Accounts receivable financing is often used by companies that need working capital. Obtaining capital immediately may be necessary to weather this crisis. This kind of financing enables companies to obtain early payment from a financing company on their outstanding invoices by committing to the financing company its accounts receivable. In this way, businesses can immediately improve cash flow and pay outstanding obligations.

There are two primary types of A/R financing.

Factoring

Factoring companies buy receivables owed by a business's customers for a discount. The factor then collects payment on the receivables from those customers. Factoring thus helps companies free up capital that is tied up in accounts receivable and also transfers the default risk associated with the receivables to the factor.

The rate charged by factoring companies depends on the industry, the creditworthiness of the company's customers, average days outstanding, and whether it is recourse factoring or non-recourse factoring. In recourse factoring, the factor has some recourse against the company that transferred receivables if it cannot collect. In a transfer without recourse, the factor takes on all the risk of uncollectable receivables.

Asset-Based Lending

Asset-based lenders will advance funds against a percentage of a company's accounts receivables or inventory.  This usually takes the form of a term loan or a revolving line of credit. The assets are used as collateral for the loan.  The loan amount is based on an agreed percentage of the secured assets' value which is generally 70 to 85 percent of accounts receivable. The interest rate is determined by loan size and risk.  The APR of a loan secured by accounts receivable typically ranges from 7% to 17%.

Conclusion

Your accounts receivable are not only valuable assets, they are also a powerful tool that can give your business necessary flexibility and the ability to raise capital immediately.  Protecting and leveraging them strategically may be the antidote to the coronavirus' negative impact on your business.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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