Cutting Credit Risk While Increasing Sales and Working Capital (the Hidden Key to Global Growth)

By Sandy, Vic; Dworack, Jeffrey L. | Business Credit, June 1997 | Go to article overview

Cutting Credit Risk While Increasing Sales and Working Capital (the Hidden Key to Global Growth)


Sandy, Vic, Dworack, Jeffrey L., Business Credit


In the traditional arrangement of exchanging goods and services 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 why lenders limit 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, allowing a safe increase in 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 from 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 beneficial percentage.

As an example, a company with $15 million of pledged receivables is currently allowed to advance 80 percent, providing $12 million in available working capital. Assume additional growth opportunities require an additional $4 million. By insuring the receivables against unexpected customer insolvencies and protracted default, the advance rate can safely be increased to 85 percent. This provides an additional $750,000 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 $4.5 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 the company and their lender.

A typical credit insurance program costs .1 percent to .3 percent 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 $4.5 million of additional capital reinvested in the business at a 30 percent return on funds employed yields as incremental return of $1,350,000 from a premium investment of approximately $150,000. 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 rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Cutting Credit Risk While Increasing Sales and Working Capital (the Hidden Key to Global Growth)
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.