The future of trade credit

By Andreas Tesch

It’s often the case that you don’t really notice or appreciate something until it’s gone. Among the many issues created by the global downturn – and arguably a contributing factor – was the abrupt and widespread reduction of credit available to businesses and consumers, which had the effect of stifling trade and starving companies of cash

“Trade credit is such a crucial part of the business landscape that it reflects the prevailing environment.”
-Andreas Tesch

Suddenly the issues surrounding trade credit - extended payment terms, default and insolvency, and credit insurance itself - rocketed to the top of everyone's business agenda.  And the importance of trade credit as an aid to effective commerce was regarded in a new light.

But enough of recent history, what of the future? Will trade credit still retain its position at the core of trade, whether domestic, cross border or global? What shape will it take and what developments are likely to influence its evolution?

While these may sound like fairly simple and straightforward questions, the close inter-relationship between trade credit, business competitiveness, growth and financial stability means that the answers are often complex and will vary between sectors and, as always, will be subject to differing opinions.

Nevertheless, our 'Future of trade credit' white paper provided some interesting information on trends, attitudes and the relationships between buyers and suppliers. 

It is clear that the economic crisis has changed the dynamics of trade credit, with suppliers adopting a more aggressive stance on credit terms and enforcing payment when it becomes due. The white paper also found that, in some instances, suppliers chose to withdraw credit facilities from their customers completely, instead insisting on up-front payment to reduce their exposure to the risk of non-payment and improve their cash flow. Conversely, powerful buyers used their strength to demand longer credit terms from suppliers, which not only enabled them to hold on to their cash for longer, but also placed additional pressure on the supply chain as the payment delays would very likely be passed up the line.

Conscious of the increased risk to credit sales during the downturn, businesses also became much more focused on credit control and collections activity, using either their in-house teams, professional external providers, or a combination of both, to ensure bills were paid on time and cash flow was maintained. Even though the global economy is showing signs of recovery, it's inevitable that this tightening of credit control will be a consistent feature of trade credit procedures and business life well beyond 2011.

While a concentration on good credit management practice is commendable, if the more extreme aspects of tighter credit conditions identified in our white paper continue, such as an insistence on advance payments by suppliers or unreasonable demands for increased credit periods by buyers, then the trust, confidence and good faith that have traditionally been at the heart of trade credit are likely to be damaged, as will the longer term supplier/customer relationships.

Even so, across Europe and the many of the other countries surveyed as part of the white paper, most businesses see trade credit extending further over the next 12 months and beyond to allow customrs more time to pay - especially as there is likely to be less access to financial support in the form of loans and overdrafts.

Alongside this, there is a strongly held belief that the increase in the use of trade credit will also help maintain trust with loyal customers and assist in the regeneration of beleaguered markets. While this may not accord wholly with experience of recent times, it suggests that businesses clearly recognise the strengths and values of trade credit as part of the process of gradually improving commerce, both domestically and internationally.

With trade credit comes trade credit insurance: the ability to protect your business from the financial risks inherent in such trade. For those unfamiliar with trade credit insurance, I'll provide a very brief overview to put it into context.

When a business sells goods on credit, the expectation is that the invoice will be paid on the due date. If it's paid late, then this is in breach of the terms and conditions on which the goods were supplied. Trade credit insurance protects your business by enabling you to claim against your policy, usually up to 90 or 95 percent of the value of the good supplied, if payment is not made for a range of reasons, including the buyer's insolvency, protracted default, unstable economic environments or even political interference in completion of the contract.

Naturally, as many contributors to our white paper have given clear indications that trade credit is likely to increase in the very near future, the need for trade credit insurance will also follow this upward trend, to protect increased credit sales.

Essential to the research for the white paper, and to achieve a clear and balanced perspective to promote debate, the opinions of a number of key business organisations were sought, providing a qualitative view to augment the more statistical data.

One of these organisations was the Berne Union, the association for export and credit worldwide, whose members provided almost US$ 1.4 trillion of insurance capacity last year. They reported that, during the economic downturn, the demand for credit insurance in many countries showed a steep rise - in one instance an eightfold increase in applications.

These experiences were echoed by the International Credit Insurance & Surety Association (ICISA), although they were also keen to point out that credit insurers should help businesses understand the relationship between trading environment risk, the cost of capital and insurance premiums.

One of the measures introduced during the recession - and one that is now adopted as a common practice and is likely to remain so for the future - is the insistence on much more up-to-date financial information to enable banks, credit insurers and financial institutions to make more robust decisions.

Pre-credit crisis, annual returns and filed accounts were sufficient to gauge credit risk, as the international trading environment was generally relatively stable with little fluctuation. But the sudden and continuing change experienced across all markets and business sectors means that annual figures are rarely an accurate representation of a company's current health, wealth or prospects.

Consequently, companies have begun to provide regularly updated management accounts, which enable them to demonstrate their strengths and current financial performance and gain access to finance, trade credit and insurance.

This change in itself has already had a significant impact on the future of trade credit, enabling credit insurers to be much more confident about the risk environment as it applies to individual businesses and to provide credit insurance cover where, without this up-to-date information, it might not have been available.

So, taking all these points into consideration, what conclusions can be drawn about the future of trade credit? Trade credit is such a crucial part of the business landscape that it reflects the prevailing environment. As a result, it can possibly be said to be going through three key phases - contraction, control and confidence.

The initial 'contraction' of credit availability and trade credit provision led to the introduction of increased 'control' over payment terms, risk management, financial information, collections and a range of other measures. Now, as a result of these measures, trade credit is entering a new period of 'confidence', where it is once again 'oiling the wheels of business', but in a trading environment where its role and strengths are probably better understood and its importance has never been greater.

About

Andreas Tesch is Director Global, Oceania and New Markets at Atradius. He is a leading global authority on trade credit insurance. Beginning his career in management consulting, he joined Atradius in 2001 in Corporate Development, subsequently becoming Director of Risk Services for Central and Eastern Europe (2004-2006).