Protecting your business against defaulting debtors
At the height of COVID-19, the Government implemented a range of temporary measures to help businesses respond to economic impacts of the global pandemic. All of these measures – which included tax relief and other leniency measures – have now expired and business insolvencies are returning to pre-COVID levels.
Statistics from the Australian Securities and Investment Commission (ASIC) showed the number of Australian companies going into external administration increased 23% over the year to the June quarter, with 1,567 companies entering external administration or controller appointments. In just six months, from January to June 2022, some 4,177 formal insolvency appointments were made. Based on current figures, it is likely that the total number of insolvencies in 2022 will be significantly higher than in both 2020 (7,041) and 2021 (6,243).
Beyond the withdrawal of the COVID-19 relief measures, other factors are contributing to the increase in insolvencies, including:
- supply chain issues causing ongoing disruptions in respect to the supply and distribution of goods, delays in imports and exports, availability of products and materials, labour supply, worker mobility and other barriers to production
- acute skill shortages
- inflation being driven higher by post-COVID supply chain shortages, inclement weather on the east coast, and pressures on global food supply and energy shortages attributed to the war in the Ukraine
- interest rate rises, with the RBA lifting the cash rate to the highest level since 2015
- slowing economic growth, and
- ATO enforcement action to ensure businesses are maintaining their taxation obligations.
Interestingly, insolvencies in health care and social assistance doubled over the year to June 2022, as demand for the services which rose during COVID tailed off. The professional services, administrative and support services, and utilities sectors have been particularly hard hit by skills shortages and have also seen more insolvencies. Rising costs, supply shocks and labour shortages have resulted in an increasing number of developers, builders and contractors entering external administration as well.
Economic conditions mean rates of payment defaults are set to rise.
According to CreditorWatch, trade payment defaults – money owed between businesses and a key insolvency indicator – are at their highest since October 2020. The Business Risk Index indicated business-to-business payment defaults increased 53% over the past year. It also found court actions were up 51% year-on-year and forecast these will continue to rise. External administration was up 58% year-on-year and up 129% since January 2022. The national default rate was 5.8% in August 2022 and the analysts continue to forecast a rise in business insolvencies throughout the year as multiple adverse impacts batter the economy and make it that much harder for some businesses to pay invoices.
Payment defaults are a key indicator of coming delinquency for the debtor/ customer.
Approximately 25% of businesses with a default end up in administration within 12 months, according to CreditorWatch. That then puts pressure on the supplier who will have to shoulder the bad debt. A business with a trade payment default is seven times the default risk compared to a business with a clean payment record.
What insurance and risk management solutions are available to protect businesses?
Businesses of all types and sizes can face the challenges associated with cash flow and debt risks. Late payments and bad debts are the main triggers of insolvency in many companies and, if one of a business’ key customers becomes insolvent, their own financial position can be jeopardised. Debtor non-payment and insolvency can have a domino effect.
Trade credit insurance is an effective risk mitigation tool that can help protect the business against debtors (customers or sub-contractors) failing to pay for goods and services provided to them on a credit basis.
The cover insulates businesses like manufacturers, traders and service providers from the financial ramifications of non-payment of a commercial trade debt due to debtor insolvency and protracted default events. It works by the insurer effectively buying the policyholder’s bad debt exposure risk (premiums are generally priced at less than 0.3% of insured turnover and the cost is tax deductible).
If a customer does not pay (often due to bankruptcy or insolvency) or pays very late, the policy will pay out a percentage (usually 90%) of the outstanding debt – protecting the policyholder financially by safeguarding cash flow and business solvency.
Trade credit insurance may also help facilitate business growth.
Beyond preventing bankruptcies, the cover can help businesses manage credit and even present opportunities for business expansion.
Having the insurance often affords the policyholder greater confidence to enter into relationships with existing and prospective customers where transactions will be based on offering credit.
In addition, being insured may make a business a more attractive trading partner to larger suppliers. It can also provide a lender with the collateral needed to enable the business to obtain additional finance if the bank or credit provider is reluctant to lend on the basis of outstanding debts.
As trade credit insurers use credit intelligence and risk ratings, policyholders may also benefit from their insurer’s insights into the financial status of existing and prospective customers, helping to identify potential risks and informing decisions on whether to trade with a business and on what terms.
Talk to your EBM Account Manager about reviewing your risk exposures and helping you secure the right trade credit insurance.
