Representing
the Following Underwriters
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Cutting
Your Risk, Europeon Style
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Reprinted
with permission from Detroiter - April 1997
By Jeff Dworack
Global Commercial Credit
For many companies, the
overseas market place represents their best growth opportunity.
As barriers fall, and the world truly becomes a much
smaller place, foreign competitors are looking to the
United States as a growth opportunity for their companies,
as well. This growth potential abroad, and competitive
pressures to secure market share, are two key forces
pushing more and more companies into the export arena.
For decades European companies
have relied on export credit insurance to hedge the
risk of selling into other countries on open credit
terms. While gaining in popularity and use in the United
States, this financial instrument is still widely unknown.
Export credit insurance has two basic components - commercial
risk protection and political risk protection.
These programs
provide the exporter with several tangible financial benefits
including:
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Protection
from unexpected customer defaults due to a broad range
of insolvencies, or protracted default. The policy
is designed to help exporters eliminate the potential
for loss on their overseas open credit customers.
When exposures are large, or terms are long, this
protection can eliminate the devastating impact on
working capital and reserves that results from credit
defaults.
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Securing
a more competitive market position. The ability
to offer aggressive open credit terms can enhance
the exporters' ability to meet a customer's needs.
As competition in the global marketplace heats up,
more and more companies are demanding open credit.
By utilizing credit insurance to hedge the risk of
loss, exporters can extend open credit that will permit
foreign customers to more easily purchase the quantity
of product or service that they truly desire. Further,
by eliminating the need for letters of credit, exporters
help their customers keep their working capital lines
of credit available for other uses. In competitive
bid situations, it may make the difference between
securing the contract and losing the business.
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Allowing
exporters the ability to pledge export receivables
and insured purchase orders as collateral for working
capital financing. By eliminating the risk of
loss, the exporter can create a "riskless"
asset that can be included in the borrowing base along
with domestic receivables.
Export credit insurance
has truly proven to be one of today's greatest hidden
keys to global growth and export success. If you are
in search of more working capital, and pledge your accounts
receivable as collateral against your working capital
line of credit, and make sales to overseas accounts,
you may want to read on.
In this traditional arrangement
of exchanging cash today for the promise of cash tomorrow,
we all realize there are many inherent risks, not the
least of which is unexpected customer defaults. The
risk of an unexpected customer default is a driving
reason behind limiting advances on pledged receivables.
Prudent lending practices dictate that lenders extend
themselves only to a certain point, since the potential
for default in the receivable base can place an undue
repayment burden on the borrower. Obviously, this limits
the amount of working capital available from a given
group of accounts.
Many companies
in periods of rapid growth, or faced with new revenue
opportunities need access to additional working capital.
The traditional approach has been to secure additional
assets or provide personal guarantees. For some, these
options are not feasible or desirable.
A more cost effective
alternative is to hedge the risk in pledged receivables,
and increase the advance rate. A financial instrument
known as accounts receivable insurance, which is commonly
used in Europe, and has been available in the United
States for over 100 years, can be used to transfer the
risk of unexpected credit losses off of the company's
books. By eliminating this potential for loss, it is
possible to more fully leverage the pledged receivables
and increase advance rates by a useful percentage.
For example, a
company with $10 million of pledged receivables is currently
allowed to advance 80%, providing $8 million in available
working capital. Assume additional growth opportunities
require additional $3 million. By insuring the receivables
against unexpected customer insolvency's and protracted
default, the advance rate can safely be increased to
85%. This provides an additional $500,000 of working
capital. As the receivables turn, say six times for
this example, that increased availability provides additional
working capital at every turn, resulting in $3 million
in additional funds accessible to the company. Further,
by guaranteeing payment on the receivables, the lender
enjoys the benefit of advancing against a "riskless
asset". This approach is a win-win opportunity
for everyone.
A typical credit insurance
program costs 1/10% to 3/10% of covered annual sales
for a domestic receivables policy, and slightly more
for export programs. The return on additional funds
employed in the business assures the company a sizable
return on the initial investment. In the preceding example,
the $3 million of additional capital reinvested in the
business at a 30% return on funds employed yields an
incremental return of $900,000, from a premium investment
of approximately $100,000. Additionally, the policy
allows the company to replace reserves with a tax deductible
premium that places a firm guarantee of payment on the
accounts, and eliminates the need for excess reserves.
The end result
is an immediate increase in working capital, increased
sales, and increased future sales revenue, while the company
preserves remaining assets for future financing needs.
Overall, you may find that credit insurance is the ideal
solution to a number of very common dilemma's.
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