Credit risk: a threat to the self-employed and businesses

Last October, the daily newspaper *24 Heures* reported that nearly 2,800 Swiss companies had gone bankrupt between January and September 2020 (according to a study by Bisnode). However, although these bankruptcies occurred against the backdrop of a global health crisis, they remain attributable to a variety of factors, notably late or non-payment by third parties; a major financial risk known as ‘del credere risk’.

What is credit risk?

Origin of the term “ducroire”

In finance and law, the duty of care makes an intermediary jointly and severally liable for their client’s debts in the course of their duties. Usually arising from a signed contract, this duty encourages the intermediary to finalise a sale only when their client provides sufficient guarantees of solvency.

The credit risk obligation can therefore entail a risk, insofar as the intermediary is not always able to accurately verify the creditworthiness of their client, which may, in particular, vary over time…

Good to know: Although they share a common origin, the del credere obligation and del credere risk are indeed two distinct concepts.

Definition of del credere risk

By definition, credit risk refers to a buyer’s or their guarantor’s refusal to pay or insolvency. Also known as ‘commercial risk’, credit risk therefore relates to the sale of goods or services on credit.

If a company (whether in the public or private sector) delivers its services or goods immediately, whilst the buyer is granted a payment term of several weeks or even several months, the company runs the risk of late payment, or non-payment in the worst-case scenario.

This credit risk therefore threatens the company’s financial health by disrupting its cash flow, particularly if the exposure relates to a significant proportion of its turnover.

Indeed, commercial risk is particularly prevalent in B2B (where businesses supply other businesses). As orders are much larger than in B2C (where businesses supply individuals), it is very common to grant customers payment terms ranging from 30 to 90 days…

Of course, large companies with a healthy cash flow can afford to take on a certain amount of trade credit risk. However, the self-employed and SMEs are particularly vulnerable in the event of default or late payment by their customers, given their limited financial flexibility.

The different types of del credere risk

Self-employed individuals and businesses that sell goods or services on credit are exposed to three main types of credit risk, namely:

• The risk of late payment. Although this risk may seem minor at first glance (a delay of just a few days has little impact on the business), it can lead to significant difficulties and costs if it drags on (a delay of several weeks or more requires a great deal of follow-up work and creates a cash flow shortage that is dangerous for the business).

• The risk of non-payment. This risk, which is highly detrimental to the business, covers all situations in which a customer refuses to pay for the goods or services they have purchased, regardless of the reason for the refusal. This results in a significant loss of revenue for the business, as well as the need to initiate lengthy and costly procedures (debt recovery, legal proceedings, etc.).

• The risk of non-payment. This risk relates to situations where the customer is unable to settle their debt with the company, for example due to temporary financial difficulties or even bankruptcy. Here too, the financial loss to the company can be significant, and recovery of the debt can take a very long time (or may even prove impossible).

How can you protect yourself against the risk of bad debt?

Stop selling on credit

As it is an inherent part of selling goods or services on credit, the risk of bad debt can only be completely avoided by simply refraining from this type of sale! In fact, requiring payment before the goods or services are delivered (as is always the case in e-commerce, for example) is a way of protecting oneself against commercial risk.

Taking out credit insurance

However, it is possible to protect oneself against the risk of bad debt whilst continuing to offer payment terms to customers by taking out credit insurance.

There are, in fact, insurance policies specifically designed for SMEs to cover non-payment for goods or services supplied on credit: if non-payment is confirmed, the business is compensated in accordance with the terms of its insurance policy.

The terms of a credit insurance policy can vary considerably depending on the circumstances. They generally take into account:

• the risk profile of clients;
• the type and cost of the goods or services sold on credit;
• the cost of the insurance and the cover options chosen by the insured company.

Good to know: Some credit insurance policies even cover businesses against the risk that documents essential for the payment of goods or services supplied have not been drawn up or registered.

Consult a specialist

Finally, some companies use specialist services to protect themselves against the risk of bad debt. These services generally offer comprehensive cover, including credit insurance (which already provides good protection), invoice financing and even debt collection services in the event of actual non-payment.

This solution offers tailored cover, tailored to the company’s needs, and provides access to expert services.

Finally, another option available to you for eliminating your credit risk is to sell your receivables to a third party. Your customer receivable then changes hands, and you receive a portion of the amount originally invoiced to your customer (depending on the probability of recovery as estimated by the purchaser).

In short, credit risk is the risk of non-payment by the buyer in a credit sale. If not managed properly, it can quickly cause difficulties for the self-employed and SMEs that do not have sufficient cash flow.