Bad Debt Reserves vs. Factoring vs. Letter of Credit vs. Credit Insurance

Bad Debt Reserve vs. Factoring vs. Letter of Credit vs. Credit Insurance

Recap: Bad Debt Reserves vs. Factoring vs. Letter of Credit vs. Credit Insurance

Option 1: Self-Insurance (Bad Debt Reserve)

Definition: Use of a bad debt reserve to offset losses should any customers become unable to pay


Pros of Bad Debt Reserves: 

  • Minimal cost to the company in years with no losses
  • Simple to administer

Cons of Bad Debt Reserves:

  • Company bears burden and cost for internal credit management resources needed to mitigate risk
  • Depending on risk tolerance, may result in overly conservative limits that reduce potential revenue
  • Ties up working capital that impacts capital allocation of the balance sheet
  • Typically does not protect from large and unexpected catastrophic loss
  • Utilize unreliable third party data services

Option 2: Factoring

Definition: An agreement with a third party company to purchase accounts receivable at a reduced amount of the face value of the invoices


Pros of Factoring: 

  • Immediate access to ccash
  • Option to outsource invoicing, collections, and other bookkeeping activities
  • No long-term contracts
  • Doesn't require collateral

Cons of Factoring:

  • Depending on contract structure, may not protect against non-payment events
  • Loss of control of customer relationships
  • Capacity constraints associated with line availability
  • Cost range between 1% and 4% of a receivable plus interest on the cash advance that can equal up to 30% in annual interest
  • Does not indemnify full invoice

Option 3: Letter of Credit

Definition: A bank guarantee that the payment of a buyer's obligation will be received on time and in the correct amount

 

Pros of Letter of Credit: 

  • Security for both seller and buyer
  • Financial standing of the buyer is replaced by the issuing bank
  • Because of the guarantee, seller can borrow against the full receivable value from its lender

 

Cons of Letter of Credit: 

  • May only cover a single transaction for a single buyer and can be tedious and time consuming
  • Expensive, both in terms of absolute cost and credit line usage with the additional need for security
  • Ties up working capital for the buyer
  • Competitive disadvantage when competitors are offering open terms
  • Lengthy and laborious claims process

Option 4: Credit Insurance

Definition: A business insurance product that protects a seller aginst losses from nonpayment of a commercial trade debt

 

Pros of Credit Insurance:

  • Empowers companies to confidently gorw sales without credit concerns
  • Guaranteed protection against non-payment or slow payment
  • Enhances efficiency of a company's internal credit department with fast credit limit requests and ongoing buyer monitoring
  • Allows exporterrs to offer safe, open terms overseas
  • Expands a company's financing options by increasing its borrowing base with secure receivables

 

Cons of Credit Insurance: 

  • Most cost-effective for businesses with $3M in B2B sales
  • Not suite for companies with only government or B2C sales
useful description of image if informative and not decoration only.
You can also call an expert at 410-316-6164
Euler Hermes Research Icon
We're constantly researching trade, non-payment, economic and business trends. Check out our latest articles to get tips that can help your business survive and thrive.
 
Read Our Latest Articles
Risk Report Icon
Euler Hermes' sector risk ratings measure the risk of non-payment for numerous industries around the world. Learn about demand, profitability, financing and competition risks.
 
View Sector Risk Reports
Partner with EH Icon
Our trade experts can leverage proprietary Euler Hermes data and insights you provide to help you analyze the creditworthiness of your new and existing customers.
 
Request a Free Quote
We're always producing new content to help businesses understand economic trends and navigate trade uncertainty.
Sign up for our newsletters to make sure you don't miss anything.
Subscribe Today