Trade Credit Insurance Vs. Factoring: What’s The Difference, And What’s Right For Me?
If you’re part of a business that has many international clients, you’re probably somewhat familiar with trade credit insurance and factoring. But you may be a bit confused about the difference between the two, how trade credit insurance and factoring are related – and how they’re different.
In this article, we’ll explain all of the basics, to help you understand the differences, and what may be right for you, to protect your accounts receivable and make sure you get paid on the due date of your invoice.
The Basics Of Trade Credit Insurance
Trade credit is, essentially, the credit line that your company extends to another company when they purchase your goods or services. If you bill someone on “Net 30” or “Net 60” terms, and they have 30-60 days to pay you, you’re extending them a line of credit.
You can incentivize your clients to pay by offering small discounts – such as a 2% discount – for paying within a certain time period. However, if your client does not pay, what happens?
If you do not have trade credit insurance, you may have to send this bad debt to a number of collections services, and try to get the money you’re owed from your client. But this can take quite a bit of time, and you may never get the full amount you’re owed.
This is what trade credit insurance companies are here for. Trade credit insurance is used for credit protection. Essentially, you take out a policy on your invoices. Then, if an invoice is not paid for some reason, the trade credit insurance company will pay you a percentage of that invoice’s value – based on the premiums and coverage you’ve negotiated.
While credit insurers insure you from a client who refuses to pay, a factoring company gives you a way to get working capital for your company, by using your outstanding invoices as collateral.
Wondering about the basics of how factoring works? Basically, a factoring company will buy your invoices for a set percentage of their value – usually around 80%. You’ll get that money immediately.
Then, once your invoices have been paid to the factoring company, you’ll get the rest of their value – minus any applicable fees. This may sound somewhat similar to trade credit insurance, but it is not – for one big reason.
Factoring Usually Does Not Protect You From The Risk Of Non Payment
The big difference between trade credit insurance and factoring is that factoring is not a way to protect yourself from the risk of non-payment. This is because most factoring companies use “recourse factors.”
A recourse factor agreement states that, once the terms of the initial invoice have eclipsed and the debtor refuses to pay, you must purchase that invoice back from the company – and your credit department must continue pursuing the debt on their own.
It is very rare to work with a company that does not use recourse factors. Those that do offer non-recourse factoring typically charge an extremely high fee – and they only pay for bad debt if it’s caused by bankruptcy. If the client simply refuses to pay or disappears, you still have to buy back their invoice from the factoring company.
Essentially, you cannot hope to get rid of bad debt by offloading it onto an invoice factoring company.
When Should I Use Trade Credit Insurance Or Invoice Factoring?
If you are worried that your invoices won’t be paid – because you’re exporting to a newer company, or because you’re working in a politically unstable region – trade credit insurance is what you’ll want. Even if your client never pays you for your goods or services, you’ll be able to recover most of the value of the sale, and ensure your business stays in good financial shape.
In contrast, invoice factoring should be used when you’re sure that your clients will pay eventually – but you’re having short-term cash flow problems. Maybe you’ve got a few dozen Net 60 invoices out there, but you need to make payroll and invest in some upgraded equipment within the next month.
By using a factoring company, you can access the money you’re owed more quickly, and use it for mission-critical operations and other business needs. Just don’t think that you’ll be able to “dump” bad debt with invoice factoring – The use of recourse factors mean that this is simply not possible.
Learn More From Niche Trade Credit Now!
If you’re running a business in Australia, and you need trade credit insurance, Niche Trade Credit is the best choice.
To get more information about our services, and get a quote for your company, please get in touch with us online right away, or give us a ring at 02 9416 0670.
We’d be happy to continue this discussion with you in-person, and help you develop a deeper understanding of the benefits of trade credit insurance services.
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