Cover Your Assets

Providing credit to your customers is a good thing -- until they stop paying.

Anyone with a pulse can get credit these days. A look at the astronomical foreclosure rates on U.S. homes is a good indicator that some folks have overextended themselves, and it doesn't stop there.

Many businesses also fall into the "in-too-deep" financial category. Your customers could have a bad-credit rap sheet that could stymie your operations by stopping incoming cash that feeds your bottom line.

Indeed, according to the Euler Hermes ACI Business Failures Index, the economic downturn that began in 2007 will increase risks for companies and higher bad debts, leading to a sharp increase in the number of U.S. business bankruptcies this year. Euler Hermes ACI is a provider of trade credit insurance.

The Business Failures Index includes a revised 2007 outlook, which now forecasts a 51% increase in U.S. business bankruptcies for the year. This follows a spectacular but one-off reduction in business failures in 2006, when the number of corporate insolvencies dropped by 50% due to a change in U.S. bankruptcy legislation.

Bankruptcies on the Rise

According to the U.S. Bankruptcy Courts, 6,705 businesses declared bankruptcy in the second quarter of 2007. That number represents a:

  • 7% increase over the first quarter of 2007
  • 38% year-over-year increase from the second quarter of 2006
  • 45% increase for the first half of 2007 in comparison to the first half of 2006.

Daniel North, chief economist for Euler Hermes ACI, says the three most serious issues facing U.S. businesses right now are: the effects of increased energy, raw material, and labor costs; the effects of monetary policy tightening by the Federal Reserve in 2004-2006; and the "decimated" housing market and its effects on consumers and businesses.

Euler Hermes is forecasting as many as 30,000 business bankruptcies in 2007.

"We are forecasting that business bankruptcies in the U.S. will rebound in 2007 due to the slowdown in the economy, lower profits and the disappearance of the impact of the change in legislation," says Daniel North, Euler Hermes ACI's chief economist. "We anticipate a return to some 30,000 insolvencies this year."

Globally, the Euler Hermes research department is forecasting a 7% rise in business failures for 2007.

Enter trade credit insurance, a business insurance product that indemnifies a seller against losses from nonpayment of a commercial trade debt. With trade credit insurance in place, the seller/policyholder can be assured that undisputed accounts receivable will be paid, either by the debtor or the trade credit insurer within the terms and conditions of their policy, according to Euler Hermes.

Indeed, several manufacturers have purchased trade credit insurance for myriad reasons.

One of Euler Hermes' customers, a furniture components manufacturer based in Tennessee, bought the insurance to mitigate risk and achieve better banking terms, which allowed the company to offer extended terms in order to be more competitive.

Euler Hermes alerts the furniture manufacturer about troubled companies, enabling the company to reduce its exposure and avoid unexpected losses.

Bullying Tactics Don't Pay Off

"The impact of rising energy costs on the supply chain requires better methods than beating suppliers for cost reductions, which do not pay in the long run. And passing costs along to customers is not a viable option. The only viable solution for the distribution supply chain is to achieve higher levels of personnel efficiency, coordination, planning and productivity."

-- Brian Devine, vice president of ProLogistix

Another Tennessee company was able to collect one-third of its receivables when discount retailer Kmart filed for bankruptcy protection in 2002. The company, which manufactures women's and misses outerwear, states, "Our bank has a favorable look on our open receivables due to credit insurance."

Notes Joe Ketzner, executive vice president for Euler Hermes ACI, "As important as it is to know what trade credit insurance is, it is equally important to know what it is not. Trade credit insurance is not a substitute for prudent, thoughtful credit management, and sound credit management practices must be in place before a trade credit insurance policy is bound."

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