Factors Contributing to Credit Risk - A Review of 2023

In the ever-evolving landscape of domestic and global trade, businesses face a myriad of challenges, with one of the most critical being the management of credit risk. As a specialist trade credit insurance broker, we play a pivotal role in helping businesses to navigate these uncertainties.

In this review, we look back on 2023 and discuss the various factors that contribute to credit risk in the business world today.

Financial Stability of Your Customer:

• The financial health and stability of your customer plays a fundamental role in assessing credit risk. This includes analysing the company's financial statements, income, and liquidity ratios. Companies with inconsistent or negative cash flows, high levels of debt, or poor profitability may pose a higher credit risk.
• The trade credit insurance market can assist with managing this risk as insurance companies often have access to information that is not available in the public domain – for example, a company’s set of management accounts, or cash flow forecasts.

Industry and Economic Conditions:

• Economic cycles and industry-specific conditions can significantly impact a customer’s ability to settle unpaid debt. For example, credit risk in the construction sector is particularly high: in the UK, construction accounts for almost a fifth of all corporate insolvencies in the country and figures have risen by an additional 4% year on year in Q1-Q3 2023 (Source: Tokio Marine HCC).

Market Conditions:

• Volatility in commodity prices, currency exchange rates, and interest rates can affect the financial performance of businesses. This seems to be the common theme throughout this year, with more and more companies being exposed to unpredictable market conditions. This ultimately impacts the cash flow of a business and therefore increases the likelihood of credit risk.
• Allianz Trade have reported that the UK is already seeing a sharp acceleration of business insolvencies. Their economists expected business insolvencies to increase by 16% last year (2023), 5% this year (2024) and stay around 30% above pre-pandemic levels until 2025. (Source: Allianz Trade).
• Trade credit insurance provides a safety net for businesses by compensating them for the losses incurred when a customer becomes insolvent and is unable to fulfil their payment obligations.

Global and Political Risks:

• Businesses engaged in international trade may face increased credit risk due to geopolitical events which are outside the control of you and your customer. An example of this could include when government actions and economic deterioration prevents currency conversion or transfer, ultimately prohibiting your customer from being able to pay you. This may be the case even if your customer had sufficient funds to settle their debt.
• Trade credit insurance can provide cover for these type of situations under political risk cover. This cover is essential if you are trading in volatile markets overseas.

Business Relationships and Supply Chain Dynamics:

• Dependence on a small number of customers or suppliers can increase credit risk. For example, if a major customer faces financial difficulties, it can impact the entire supply chain.
• Understanding the interconnectedness of businesses within a supply chain is crucial for assessing the potential impact of credit risk.

Credit History and Payment Behaviour:

• A customer’s credit history and past payment behaviour provide valuable insights into their creditworthiness. Late payments, previous defaults or a history of financial mismanagement can indicate an elevated credit risk.
• Credit insurers are fed live information from their policyholders that tracks payment performance on thousands of companies. Access to such information proves invaluable when you are trading with customers on credit terms.

Credit Policy and Internal Controls:

• Enhancing your credit policies and strengthening the internal controls within your business can assist in managing credit risk more effectively. Poor due diligence in assessing customers, insufficient monitoring of credit exposures, and weak risk management practices increase the likelihood of credit defaults. As a consultant that provides risk management expertise, we will review your ledger and discuss policy and cover options with you to ensure your credit insurance policy is bespoke and fit for purpose.
• Policies can be all-vetting in nature meaning you rely on the credit insurer’s intel to set and monitor your customer’s credit limits. Advances in technological capabilities also means that the insurer’s online portal can link to your accounting package, removing the burden on you to monitor your credit exposures.
• For larger corporate businesses with robust credit control procedures and financial management plans in place, we can source Excess of Loss solutions that can be structured for catastrophe type scenarios. This saves your time, resource, and investment in setting up captive-type alternatives.

 

For further information about trade credit insurance and to discuss how we can help your business protect against credit risk, please contact our specialist team today.