Credit advice

Many suppliers ask risky customers for an advance before releasing goods or providing a service. Normal credit is then allowed on the balance, e.g. '20% before dispatch, balance at 30 days from receipt'. The mean risk is reduced and the customer has time to organise payment of the balance.

You can generate customer confidence and reduce credit risk by using a neutral body such as a bank to hold the funds until the buyer is happy. There are many forms of trusteeship, secure deposits and escrow accounts to achieve equitable arrangements.

In building work and related contracting there are problems of credit risk, quality disputes and cash flow. But the contractor needs working funds. A Stakeholder Fund can generate client confidence, keep the contractor up to the mark and encourage a bank to advance money for the work.

For example, where the contract terms are 'one-third on contract, balance on satisfactory completion', the client is asked to deposit the initial third into a nominated bank account held for the seller. The stakeholder bank will only release the funds on the written instructions of the purchaser or an agreed arbitrator. The seller will be keen to satisfy the client to obtain payment. If the seller is at fault, the advance may be refunded by the stakeholder bank.

In the building/contracting industries and others where technical disputes often delay payment, the fear of large legal costs deters many firms from suing for their money. Some debtors are suspected of keeping disputes running if they think a supplier cannot afford litigation.

Insurance cover can be available for legal expenses if you have a good case. A broker's help is advisable for negotiating terms. The building industry, for example, has an insurance scheme at Lloyds for members and non-members.

It is important that unpaid sellers feel confident of having disputes settled in court if needed. If debtors are told that legal costs are not a barrier because they are insured, disputes may well be settled quickly without going to court.

When a risky customer needs time to pay, the credit period can be limited to 7 or 14 days instead of the normal 30 days. Accounts on special terms should be grouped together in the ledger for constant collection attention. Any default after agreement of special terms should lead to 'cash terms only'.

This is an expensive inducement to obtain payment from a customer and needs to be treated with caution. It is only viable when your net margin is high and you have the staff to control unauthorised deductions. If only bad payers are offered cash discounts, all your good payers will want the same benefit.

Terms of '2% 10 days, net 30 days' should produce fast payment because a customer would be silly to ignore the effective lower net price. Your annualised cost is huge (36% pa for the example above) and more expensive than waiting an extra 2 months for payment. Also, it is difficult to recover deductions from payments made too late to qualify.

If you give volume price discounts on invoices to customers who then pay late, you are suffering a double cost. Instead, agree each year with customers to rebate the discounts by quarterly credit notes, but only for invoices paid on time. Buyers usually make sure they qualify for the lower price.

This is a written undertaking by a third-party to be legally liable to pay you if your customer does not. Since the wealth of individuals is uncheckable, limited company guarantees are preferable. Sole traders and all partners in partnerships are personally liable for their business debts anyway. Directors are not liable for their companies' debts.

Parent companies are not liable for their subsidiaries debts unless they issue guarantees. 'Comfort letters' which confirm the shareholding, are not guarantees and should be rejected.

Banks sometimes guarantee payments to suppliers when the debtor is under-capitalised, e.g. in a start-up, where the bank has lent initial funds and wants the venture to succeed.

Wording of guarantees can be obtained from solicitors, credit insurers and credit management books. Guarantors may insist on limiting the amount and expiry date. Give the wording to your debtor who should ask the guarantor to issue on their own headed paper.

About half of all newly-formed businesses do not last two years! It makes sense to restrict initial credit and, for large orders, to get payment guarantees.

If your goods (not services) remain easily identifiable as supplied by you, you should have a condition of sale which makes the goods your property until paid for. You may then recover them at any time, but especially when a customer is in difficulty.

You should notify customers of the new clause and make sure it is simple but clear. An 'All Sums Due' clause allows you to recover your goods against any monies owed to you, not just the debt for the goods recovered.

Retention of title clauses are not appropriate if your goods are to be processed or incorporated into something else. They also need very careful wording so they are appropriate to your business. It is advisable to seek legal help in drafting.

If you have any debtors who are also suppliers, you should not just withhold payments to them because they are overdue to you. The contracts are quite separate. For example, the Receiver for an insolvent customer can require you to repay amounts already offset. Instead, have simple written agreements with common customers/suppliers that debts may be offset, and any excess paid by the party concerned.

What is trade credit insurance ?

For all businesses, extending credit to customers involves a certain amount of risk. You can, however, minimise this risk by insuring yourself against the possible default and insolvency of your customers. Trade credit insurance covers businesses against the risk of bad debt due to the insolvency or protracted default of their buyers. Credit insurance covers thousands of businesses who trade within the UK, but has perhaps been better known for its application to export businesses. Trade credit insurance can be an important tool in credit management. It can also provide a replacement of working capital when bad debts and late payment impact on cashflow. Credit insurers

(i) help their customers to manage credit risks more effectively and

(ii) provide the protection of insurance cover within the terms of the policy.

Types of Policy and Cover

Most trade credit insurance is tailor-made. The needs of businesses vary so widely that a standard policy will not fit all cases. A number of insurance companies underwrite trade credit insurance but many tend to specialise in particular areas. Some companies, for example, concentrate on insolvency and default, usually on a 'whole-turnover' basis. Other companies concentrate on 'specific accounts' cover. Again, some companies cater mainly for 'bulk buying' businesses whereas others underwrite businesses involved in one-off special situations. The cost of the insurance premium will vary and will be dependant upon the type of cover required. As with any commercial transaction it is important that businesses shop around to obtain the widest possible cover at the best available price. Whole-Turnover Policy covers the whole of the policyholder's business and allows the policyholder to grant credit up to a stated limit. Above this limit, credit must first be agreed with the insurer. Insurers are geared up to give their customers speedy and accurate decisions on credit limits for new buyers. Specific Account Policy can be on a fixed or adjustable basis and will cover a number of named buyers. The premium will be based on the amount of debts outstanding, among the named buyers, at any one time. If a specific account policy is underwritten on a turnover basis this will apply to a single contract or series of deals with one or more named buyers, generally for a period of 12 months only. The premium payable will be based on the value of the contract or on the volume of turnover during the lifetime of the policy. Another form of specific account cover can protect against loss arising from the policyholder's failure to complete contractual obligations of a financial nature. Supplier Default Cover protects against any loss as the result of the insolvency of a supplier. Delivery Guarantee Cover compensates a customer in the event of a supplier failing to meet delivery commitments. This form of cover originally applied only to British exporters to the EU but is now available, from some insurers, for transactions within the UK. Credit Guarantee Cover requires full consultation between the purchaser and the insurer. It enables a purchaser to provide the seller with a specific credit insurance on that purchaser. Variations are available to all forms of policy.

For example: First loss can be included on each and every account which is insured. An amount is deducted from every loss before the insured percentage is applied to the balance. Again, this helps to lower the cost of insurance. Annual aggregate first loss is a limit set within a policy up to which accumulated qualifying losses are not payable by the insurer. The insurer is only liable for qualifying losses once the aggregate first loss is exceeded. By accepting an aggregate first loss it will usually mean a lower cost for insurance as the policyholder is bearing the first part of the risk themselves. Threshold is a level of loss below which there is no claim under the policy. Policies can be worded to protect a buyer where whole or part payment has to be made in advance of manufacture or delivery. Some form of cover against pre-delivery risks may also be included.

Principal Considerations

Trade credit insurance can provide a range of benefits for small and medium sized companies. However, they are not necessarily suitable or available for all businesses. There are a number of considerations to be made by both the insurer and the business seeking cover. Credit Control The insurer will want to see certain minimum standards of efficiency in credit control. They will, for example, want evidence that trading terms are clearly defined and agreed between the parties and that credit application forms are always completed by customers. Once in force, a well designed credit policy will not only help a business to avoid late payment and bad debts, but also to increase sales. Credit Limit The credit limit amount is the key element in credit insurance policies and is the maximum amount for which a business can be insured in respect of a buyer at any one time. This limit is set by the insurer. Premium Rating and Cost Determining costs of trade credit insurance can be difficult because 'tailor-made' policies are so common. Insurers will, however, look at a range of criteria before designing a policy and setting a premium rate.

The main criteria include:

  • The annual turnover of the business.
  •  Previous experience of bad debt losses.
  • The effectiveness of the credit control system.
  • The length of credit given by the business.
  • The status of the buyers.
  • The trade sector in which the business operates.
  • The size of individual accounts and the proportion they represent of the total turnover.

Policies can be either a 'whole turnover' basis or a 'specific account' basis. Whole-turnover policies generally cost between £0.20% and £0.50% of annual turnover. Specific account policies may also be calculated on turnover but are more often rated on the amount of insured debt owing at prescribed intervals. Obligations As with all forms of insurance, the policyholder must meet certain obligations. The business must be prudent in granting credit to insured buyers. A percentage of debts will not be covered by the policy. In effect, the insurer and the policyholder share the risk, with the insurer taking 75% or 95% of the loss. The policyholder must not agree, without consulting the insurer, to postpone the due date for payment of an insured debt. The insurers can usually cancel or alter the limit of credit approved on any particular buyer. These cancellations or reductions, however, can usually be applied to future business only.

General Principles

For credit insurance, where 'tailor-made' policies are so common, it is difficult to list the underwriting principles in every case. They do, however, include:

  • Terms of payment must be appropriate to the goods or services being provided.
  • Both parties - that is the business and the insurer - should share the risk. For this reason policies generally cover between 75% and 95% of a loss.
  • The policy gives no guarantee of payment at the due date.
  • Only agreed debts are covered. There can be no claim unless a dispute is resolved.
  • In the event of an insolvency you must be admitted as an insecured creditor.


In considering whether or not to grant trade credit four basic decisions are needed. To whom, how much, for how long and under what terms. When granting cover credit insurers will look closely at the way these decisions are taken and may well suggest that the business changes or improves its credit control system. In short, trade credit insurance is designed to minimise the credit risk and to provide cover against late payment and/or insolvency.

How to buy Credit Insurance

Trade credit insurance can normally be arranged through insurance brokers or insurance intermediaries. Insurance Brokers are full-time specialists offering advice and help in arranging insurance cover. Any individual or firm using the title 'insurance broker' must, by law, be registered with the Insurance Broker's Registration Council, the body with responsibility for ensuring that the requirements of the Insurance Brokers' (Registration) Act are met. The requirements include financial controls and professional qualifications. Company Agents/Insurance Intermediaries who are not able to use the title 'insurance broker' may be company agents representing a maximum of six insurance companies, or independent intermediaries with no limit on the number of companies with whom they can deal. Both independent intermediaries and company agents selling non-life insurance must follow the ABI Code of Practice for the Selling of General Insurance. Where policies are arranged through an insurance broker or independent intermediary there is usually no charge for the service as they are paid by the commission which is met by the insurance company. Sometimes brokers are willing to arrange cover net of commission by charging a fee to the policyholder. The usual procedure is for policyholders to declare all their business undertaken with other independent businesses/third parties. Clearly, the policy cannot cover business involving associated companies, local authorities or government bodies.

As with other forms of insurance the proposer must disclose all material facts. Questions usually posed on the proposal form concern:

  • The annual turnover to be insured together with any overseas territories to which cover will apply.
  • The number of accounts and details of trading terms.
  • For whole-turnover policies - an analysis of the number and size of active accounts together with details of bad debt experience.
  • A description of the business itself and of the trade sector within which it operates.
  • Details of the method of credit control. This is an important factor in the underwriter's decision.
  • Details of any accounts which enjoy special trade terms.
  • Details of accounts which are seriously overdue.
  • As far as the main buyers are concerned, names, addresses and credit limit requirements.


Insolvency claims are payable if the underwriters are satisfied that the insured debt is admitted as an unsecured debt against the insolvency estate. For this purpose, insolvency is defined clearly in the policy wording. Protracted default is defined as existing when a buyer, having accepted delivery of goods, has failed to pay for those goods at the end of a period of 90 days after the due date. Claims for protracted default are payable within 6 months from the date on which the default occurred.

Which Businesses are Suitable for Trade Credit Insurance

Trade credit insurance is available to many businesses including wholesale. It is not so appropriate to the retail sector where the viability of buyers is far more difficult to assess and underwrite.

Further information

When seeking appropriate insurance cover it is worth taking advice on not only the cover available but on where to obtain such cover. Information on appropriate brokers can be provided by the United Kingdom Credit Insurance Brokers Committee. This body operates under the auspices of the British Insurance and Investment Brokers' Association.

British Insurance and Investment Brokers' Association

The British Insurance Brokers' Association (BIBA) is the UK 's leading general insurance organisation representing the interests of insurance brokers, intermediaries and their customers.

BIBA membership includes 1700 regulated firms . Insurance brokers and intermediaries distribute nearly two-thirds of all UK general insurance. In 2007, insurance brokers and intermediaries generated £1.5 billion of invisible earnings and they introduce £22 billion of premium income into London 's insurance market each year.

Vistit the British and Investment Brokers' Association website

Association of British Insurers

The ABI (Association of British Insurers) represents the collective interests of the UK's insurance industry. The Association speaks out on issues of common interest; helps to inform and participate in debates on public policy issues; and also acts as an advocate for high standards of customer service in the insurance industry.The Association has around 400 companies in membership. Between them, they provide around 90% of domestic insurance services sold in the UK. ABI member companies account for almost 15 per cent of investments in the London stock market.

Visit the Association of British Insurers website

Factoring is an outsourced credit management service that helps small businesses manage their cashflow.

It does this by paying most (around 80-90 per cent) of an invoice immediately after it has been issued to the customer and simultaneously chasing that customer for payment.

Businesses selling to other businesses on normal trade credit terms usually have to wait at least a month between raising an invoice and the customer paying. This usually ties up a significant proportion of working capital, which can often represent a company's greatest asset.

Factors are experts in credit management and because they are able to pay the majority of an invoice the moment it is raised, help alleviate credit risk. The remaining 10-20 per cent of the invoice, minus charges, is paid when the customer pays. More importantly, a company can concentrate on its core business, rather than worrying about chasing payment.

Around 48,000 UK businesses use factors for both domestic and international sales. A typical business using a factoring facility would be selling to other businesses and have an annual turnover of between £250,000 - £5,000,000.

A company using a factor will pay for two things: a fee for the service, around 0.5-3.5 per cent of the turnover, depending on the amount of work involved; and for the cost of the funds used, around 2-4 per cent over the base rate.

In addition, some factoring companies provide credit protection against the risk of the client's customer going out of business. This usually costs around 0.5 per cent of the turnover.

Like factoring, invoice discounting releases the cash tied up in unpaid invoices. It makes 80-90 per cent of the invoice value available as soon as it has been raised and the remainder is passed over when the customer pays.

Unlike factoring, the business retains control of the credit management function and in most cases the client's customers are unaware of the invoice discounting arrangement.

This confidentiality makes it more popular amongst more established and sophisticated businesses. Consequently, the average size of a business using invoice discounting is higher than those using factoring and is usually between £1-25million annual sales. Some 10,000 UK businesses use invoice discounting.

The fee structure is similar to Factoring although the charge on turnover is smaller because there is no credit management service. The cost of funds is also likely to be lower, reflecting the stronger financial standing of the business being funded.

In the event of periods of disruption beyond a businesses control, such as postal strikes, holiday seasons; especially the summer and Christmas, it is suggested that businesses take steps to ensure that the cash keeps coming in.

Cash flow rules for christmas

  • The Christmas holiday makes December a difficult month for debt collection and many businesses will need to step up their credit management procedures and take early action if they want to avoid late payment of invoices over this period. A little forward planning by businesses can go a long way to ensure that, as far as cash flow is concerned, they start the New Year on the right foot. To help enjoy a happy Christmas, having been paid on time and settled all their own outstanding debts, businesses should take the following steps:
  • Be aware that without forward planning the Christmas close-down period could delay payment to your firm substantially if your customer has strict payment cycles.
  • Ensure that you are aware of your major customers' Christmas opening hours to avoid wasting time when chasing payments.
  • Do not let credit limits get out of hand because of extended payment times over the December and January period.
  • Do not get behind with your own invoice and statement schedules over the Christmas period.
  • New customers seeking large credit facilities over the Christmas period may be hunting for credit from unsuspecting (and busy) suppliers.
  • Plan and budget your own expenditure over this period because, inevitably, payment terms can be disrupted over December and early January.
  • If payments from customers are due during close-down periods, attempt to negotiate earlier payment dates.
  • Take action on those accounts that are beyond credit limits now. Do not wait until the New Year when your debtors will have other pressures.
  • Use the quiet, close-down period to review your terms and conditions, ensuring that they are up to date and that they include reference to interest terms;
  • Keeping to the above rules will ensure a Happy Cash Flow Christmas!

Long term strategy for periods of disruption

  • It's easy to use periods of disruption as an excuse to ignore or delay the payment of invoices, but by thinking ahead, firms can take action as part of their longer-term strategy to minimise the likelihood of customers using these as reasons for late payment.
  • Advise customers that you wish to be paid directly into your bank account. You can do this in advance by letter or during a strike by e-mail, by providing your bank account details and giving each customer a reference number so you can identify their payment on your statements.
  • Ask customers who regularly place orders to set up a standing order with their bank to pay you a specified amount each month to cover goods purchased.
  • Consider offering an incentive to firms that agree to pay by direct debit, perhaps a one off bonus, or a discount, but be careful to cost any discount or bonus offered.
  • Ask your bank for paying in books on your account and give them to customers so that they can pay their invoices at their bank. Remember, you can fax or email invoices to the customer instead of posting them, and always provide a reference number to help reconcile statements.
  • Personal visits to customers located near you to deliver invoices and collect payment can also work well. There is no need to antagonise the customer by arriving unannounced and asking to be paid. All it takes is a quick phone call to explain the situation and to agree the method of payment. If cash payment is involved, a proper receipt must be provided for security reasons and to ensure no misunderstandings occur.
  • If you need to use a courier company to visit customers to collect payments, it may be wise to set up such a facility now, as in the event of postal disruption, you may find these companies are swamped with enquiries and you may be left disappointed.

Consider if a different approach is needed for large customers with high value orders as opposed to smaller customers who regularly order small amounts of goods.

When you're chasing invoices you come across excuses all the time. They're never very creative and more often than not are just delaying tactics. Everyone tells white lies from time to time but here are some tips for addressing the most common and least credible.

"The director who signs the cheques is on holiday."

A common excuse, especially during the summer months and before and after bank holidays, but it is frequently used to delay payments. The arguments given by debtors can be reversed and used to secure payment. If you are told the director is on holiday, find out what provision has been made for signing salary cheques and paying utility bills. Normally in these circumstances signed cheques will have been left to settle important accounts. You can put pressure on the person dealing with you by stressing how important your account is, making them feel they will be going against the wishes of their boss by withholding payment.

"The computer is down."

Find out how often these problems occur and how long faults generally last. If this is a genuine problem the debtor ought to be willing to send a manual cheque. If they refuse, it will become apparent they are trying to avoid payment.

"The cheque is in the post."

Ask for cheque and postage details. If they have not sent payment, they won't be able to answer your questions.

We are waiting for funds from a large customer and can only pay you when these funds are received.

Ask the name and address of their debtor and the expected date of payment. The company should be able to arrange some form of credit with the bank on the security of the debt. Suggest they do this and find out how quickly this can be done.

We seem to have misplaced your invoice - can you send a copy?

Ask whether this is the only reason for late payment and offer to fax a copy immediately. If the debtor does not agree to pay straightaway, they are admitting that their requests for copy invoices were a delaying tactic.