Accounts Receivable Insurance
protects clients from any loss caused by customers failing to pay for various reasons.
Accounts Receivable Insurance Details
Accounts Receivable Insurance protects loss on receivables. Meaning, that if a customer does not pay the agreed-upon amount during the established time given, the client can file an insurance claim. An accounts receivable insurance is one of the few insurance products that have payback on investment.
Also known as "trade-credit insurance," it offers protection upon unforeseen loss caused by various reasons. Mainly, this insurance product is acquired for safety if a client doesn't pay the invoice, whether because of bankruptcy or any other reason.
Businesses can file an insurance claim, and they can recuperate the loss within a fair timeframe. According to the website fidccs.com, there are five significant costs associated with accounts receivable: bad debts, interest costs, opportunity costs, administrative costs, and miscellaneous costs. Each of these terms carries various risks that show how much having accounts receivable insurance is worth.
Some foreign reversible insurances safeguard from political risks and situations such as converting currency where they can't get the money out to pay. Exports and imports are a much safer business for companies with this insurance. It also allows businesses to offer better credit terms and payment options.
Lenders and other possible investors will gain confidence and will feel assured knowing that the possibility of losing money over un-fulfilled promises isn't something to worry about. The purchase of the insurance varies depending on the amount of coverage chosen. In average cases, the cost is about 0.5% to 1.0% of the annual accounts receivable amount, although it might be different for others.
Example of an Accounts Receivable Insurance
Large Disaster Payouts
Upon loss, the insurer calculates the total accounts receivables of the year prior. They take the total sum and divide it for a monthly receivable for the next year, meaning 12 months. If a company fails due to a fire, earthquake, or any unforeseen disaster, that day will serve as the "Day 1" of the insurance claim.
A year before that date, if the said company was making $200,000 annually in receivables, then each month, it'll receive $16,666 until a year has passed. This is the case with natural disasters or anything similar to them. When a customer goes bankrupt or doesn't pay for any other reason, the process is different.
Company Collapse Payout
Imagine a customer of a business promises to pay $1.4 million for a particular service or product. This customer has been in business with the company many times before and has always paid in full and on time.
Unexpectedly, right before this purchase, this customer suffers budget cuts and poorly administrates itself afterward. They don't expect to suffer so much, but in the end, the company fails. What happens to that money that the client promised? There have been cases where insurance clients get paid millions of dollars within 45 days. Sometimes it takes longer or shorter depending on the revenue lost.
Significance of an Accounts Receivable Insurance
Some companies, especially the ones with high traffic and many customers, can't afford the time or do not have the resources to perform credit checks on all clients. Depending on the type of business, the payment can sometimes be more loose and unsecured than others. Dishonest clients might try and take advantage of such a thing, or they go bankrupt unexpectedly.
Most businesses follow the common practice of giving a net of 30 to 60 days for customers to pay. Such an extended timeframe is risky and open to unexpected events. It's not about the trust in a specific customer but protection against a possible domino effect in the industry. What if a trusted elder customer does not get paid by one of their customers? What if a political or social situation runs one of your clients out of business? Almost all companies involved in trade and extended payments should consider purchasing accounts receivable insurance.
Accounts receivable insurance takes care of real possibilities. The only way one never comes to use this insurance is if absolutely everything goes to plan. If all customers always pay, if no accidents like fires ever happen. If everything went according to plan, no one would ever go bankrupt, and no business would ever fail. The very fact of having this insurance makes it easier to go forward in business, for both the company that purchased it, and all the possible future investors and partners, and even the customers themselves.