Protecting Against Payment Risk:
The growth of your company requires establishing relationships with new customers, expanding business with existing customers, and possibly exploring new markets as well. But as you do all three, you also expose yourself to risk—there is no assurance that your customers, new and old, will pay their invoices.
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To address the challenge, you need to assess your willingness to assume credit risk and then determine whether to protect your company via credit insurance through a strong thirdparty partner or by taking on the risk internally—using the “self-insurance” approach.
Whether it’s elected by conscious choice or by default, self-insurance offers flexibility.
What Is Self-Insurance?
A company engages in self-insurance when business owners agree to accept the loss of any invoice amounts that go unpaid plus the full costs required to manage their internal credit granting processes. Businesses typically self-insure by using a bad debt reserve to offset losses and by using their own means to research customers.
Self-Insurance Drawbacks
Though self-insurance comes without a direct cost, the many indirect costs involved make it far from free for the company even in years with low bad debt losses. Consider the following potential drawbacks of the self-insurance approach:
Unpaid Invoices Weaken Cash Flow: Self-insurance directly exposes your company to the risk of unpaid customer invoices. This can occur especially during economic downturns when Days Sales Outstanding (DSO) can increase. Many bankruptcy filings occur because of payment delays that lead to an unbalanced cash flow. These companies usually suffer from poor management of customer risk. A default does not necessarily lead to bankruptcy, but if unpaid invoices by major customers accumulate, they greatly weaken cash flow and can permanently paralyze business activity.
Additional Costs Add Up Quickly: The cost of self-insurance is not easily measured. But contrary to conventional wisdom, the cost can quickly exceed the premium of a credit insurance policy when considering the effort to resolve unpaid invoices. Self-insurance requires strict organization and may generate additional expenses such as the cost to purchase customer credit information and collection costs.
More Resources Required: Managing customer risk also demands significant internal resource time and specific skills, which add to the overall cost of the business infrastructure. Additional resources are essential to search and analyze customer information in advance as well as for follow-up recovery procedures. When invoices go unpaid, the company must act quick when its payment reminders do not elicit a response from debtors. The company must then invest time, pay a significant recovery fee to a company that specializes in collections, or even commence court proceedings that require paying lawyers for legal services. Additionally, choosing to self-insure is sometimes frowned upon by financial lenders. They value the guarantees and the security offered by credit insurance, and customer hedging can reassure bankers so that they feel more comfortable offering loans.