Companies operating in today’s apparel and consumer product marketplace face a host of unprecedented challenges with the potential to devastate profitability and to crush the future of their businesses. As the landscape continues to change and management teams navigate a variety of issues — tightening margins, increased pressure for faster inventory turnaround, replacing sales for potential and current bankrupt customers, increasing e-commerce competition — the focus on decreased creditworthiness among large customers has magnified substantially.
Here are 5 “must-know” tips C-suite personnel and corporate shareholders can act on today to arm their companies against credit risk while continuing sales to large customers with diminishing credit ratings.
- Factoring: A factoring arrangement lets your company assign its receivables as collateral to a lender to immediately obtain a significant percentage of the receivable value in cash. The lender may advance as much as 85% of the receivable value and the remaining 15% upon collection of that receivable. Additionally, certain factoring arrangements transfer the risk of collectability from your company to the lender, and may provide credit insurance on the receivable if your company maintains the risk of collectability. Lenders who provide factoring arrangements may also be more flexible in structuring arrangements to assist in providing your company the needed cash-flow advances when customer credit ratings begin to diminish.
- Letters of credit (“LC”): If your customer’s credit is not being approved by your lender, this could be a red flag that their credit risk has increased drastically. In the event that your company wants to continue fulfilling the customer’s orders, ask them to provide your factory with an LC. An LC acts as a guarantee of payment once the merchandise is delivered as negotiated.
- Buying credit insurance: Buying credit insurance on your receivables acts as a hedge in the event a customer becomes unable to pay their receivable or goes out of business. Depending on the insurance policy, a claim may cover significantly all of the uncollectible receivable balance. However, buying insurance comes with costs that need to be evaluated when determining the benefits and security it provides. Additional costs to consider are premium costs and deductible limits.
- Buying a put option: If traditional credit insurance is no longer available for one of your customers, your company may consider buying a put option on the accounts receivable in question. A put option provides your company with the ability to sell the covered accounts receivable to a counter party, usually a large bank or financial institution. This option exists if the customer can no longer pay their negotiated balance per the terms of the put option. Put options typically cover the entire amount of the receivable without any deductibles, but carry a cost as a percentage of the accounts receivable in question. It is important to note the put option is often more expensive than purchasing credit insurance.
- Cash-upfront: If you can no longer extend a customer credit, ask for a cash deposit upfront. The deposit should be enough to cover your production costs.
For more information on how you can reduce exposure to high-risk customers with poor credit and protect your company, contact Thomas Miranda, CPA, Senior Audit Manager at 212.842.7518 or firstname.lastname@example.org.