It was over a year ago that the coronavirus was first detected, and while the disease didn’t bring drastic change to America until March, that first wave is now long behind us and things have only gotten worse since the summer months. But beyond the disease which has infected millions and taken many lives, the pandemic has also been devastating to our economy. While the most visible effect of the pandemic has been bankruptcies and empty store fronts, the economic effects of the pandemic actually go much deeper than that. Prior to the bankruptcies and store closures we saw a tightening of credit insurance policies combined with an unwillingness for the industry to take on new clients. The pandemic has also led to the disappearance of supply chain financing, which had grown tremendously over the past decade, while at the same time payment terms got extended. In other words, while consumers may only see the disappearance of their favorite stores and restaurants, behind the scenes the vendors who provide stores with their merchandise have not only seen reduced business, but a lack of financing available to them.
Credit Insurance has long been a tool available to wholesalers. Typically, in a business-to-business transaction, the company purchasing a product will request payment terms, meaning they won’t pay for the merchandise they receive until 30 days or more after receiving it. Of course, whenever you allow someone to pay for an item after it has been received there is risk involved. For some financially strong customers that risk may be minimal, but for others that may be struggling that risk may be significant. If a company were to file for bankruptcy within those payment terms, not only would they not have to pay you, but they will probably be allowed to keep the merchandise. Should they pay you but then file for bankruptcy within 90 days, you may be required by the bankruptcy court to return those funds. This is why many wholesalers obtain credit insurance, to protect themselves in the event that one of their customers files for bankruptcy.
Credit insurance has been around for a long time, and really hasn’t changed much over the years. Credit insurance remained available and reliable throughout the recession in 2008 and even during the current “retail apocalypse” that has followed. However, due to the rapidly changing business environment that resulted from the COVID pandemic, credit insurance had to make some major changes for the first time in recent history. Near the end of March it began with the slashing of credit limits and a refusal to take on any new clients. The credit insurance companies started lowering credit limits across the board, not only on struggling businesses, if not flat out denying coverage on accounts that they had previously covered. At the same time, they also stopped taking on new clients, even abruptly ceasing communications with potential new clients that they had been working on building policies for.
It is doubtful that credit insurance companies would have lost much money had they continued business as usual. Any outstanding receivables at the time of the initial lockdowns would still need to be covered as the insurance companies can’t backdate changes in credit limits, and oftentimes even give clients a grace period before a credit limit or coverage change goes into effect. Furthermore, businesses stopped placing orders after the initial shutdown, so there really wasn’t any need to lower credit limits. As a result, credit insurance companies didn’t really protect themselves from the bankruptcies since new orders weren’t being placed and they still had to provide coverage on orders that shipped in March or earlier, assuming they were offering coverage on these companies in the first place. The end result of their policy changes was that they turned away new business, and possibly alienated existing customers.
While credit insurance is not something that is visible to consumers, it no doubt effects consumers. If wholesalers are unable to insure an account, it makes them much less likely to be willing to sell to them. This means that the retailers have difficulty stocking merchandise on their shelves and consumers have even less of a reason to shop at their stores. All of this, combined with other difficulties caused by the pandemic, makes it that much harder for a retailer to survive, and ultimately leads them down the path of bankruptcy. However, it isn’t just retailers who got hurt by the lack of credit insurance, wholesalers may have had to walk away from some of their largest customers, putting both their short-term and long-term survival in jeopardy as well.
It is important to understand however that credit insurance companies do not have direct access to a company’s payment trends or even order history when making credit decisions. Credit insurance companies rely on credit reporting in order to get their data. The credit agencies they collect their data from receive reports from actual debtors typically on a monthly basis. Therefore, not only do credit insurance companies not have real-time data to rely on, the data they receive is not their own, and in general only places outstanding receivables into 30-day aging buckets. As a result, a receivable paid one day beyond terms would appear the same as a receivable paid 30 days beyond terms, while a receivable paid 31 days beyond terms will look much worse than a receivable paid 30 days beyond terms. The only time they receive actual real-time data is when a client of theirs has to report a receivable that has become past due by a certain number of days, and later when they ultimately file a claim on a receivable that remains unpaid. The data credit insurance companies would have had access to at the start of April would have looked perfectly normal since businesses would have been closed for at most one week at that time, it wouldn’t be until new data became available at the start of May that they would have noticed a slowdown. Any claims that they would have received at the end of March or beginning of April would have been on invoices that dated back to November 2019 or earlier. So, the decisions made by credit insurance companies in late March and early April were not dictated by data, but simply by fear of the unknown.
If tightening credit insurance policies weren’t bad enough for wholesalers, the disappearance of supply chain financing has devasted many smaller wholesalers. Larger retailers always request credit terms from their customers, typically net 30 day terms, meaning that they have 30 days to pay for their merchandise. Over the past decade, it has become increasingly popular for larger retailers to agree to pay an invoice early, oftentimes after only a week or two, in exchange for a discount. Wholesalers may be willing to give these companies a discount, somewhere around 2%, for an early payment in order to improve their cash flow, creating a win-win situation for both the wholesaler and the retailer. However, this offer of early payment is not a requirement and is solely up to the retailer as to whether or not they wish to offer it.
Supply chain financing, and Fintech in general, emerged as a result of the 2008 recession. Venture capitalists saw that financing wasn’t readily accessible to small businesses and decided to use technology to make financing safe and easy. In the years that followed 2008, our economy improved greatly and large businesses were thriving. As a result, the industry grew at a time when our economy was growing, and had never experienced an economic downturn.
Of course, prior to 2020, retailers that offered early payments would have had very little reason to stop offering it, so offers of early payment were consistently available. 2020 of course changed all that when many of these retailers were forced to suddenly and unexpectedly close their stores, as well as the corporate offices where these payments come form, for an unknown period of time. As a result, most retailers stopped offering early payments at the outset of the pandemic, putting their vendors in a difficult situation where they didn’t have access to the funds that they relied on to keep their business running. To make matters worse, with corporate offices closed and without any revenues coming in from their stores, many of the retailers simply stopped making payments, even when the invoices became due. This all happened at a time when wholesalers saw new orders completely dry up and existing orders being canceled.
To make matters worse, many wholesalers who relied on supply chain financing, never bothered to consider getting credit insurance. They didn’t see the need for credit insurance since they were getting paid early. However, just like health insurance, you still need it even if you are young and healthy because you never know what the future may have in store for you. Companies who relied on supply chain financing and didn’t bother to insure their receivables, were suddenly exposed to the fact that these companies that owe them money have now closed all their stores and that bankruptcy was a very serious possibility.
While supply chain financing was still available as a tool available to retailers, retailers no longer wished to use it. Even now, nine months after the first wave of COVID-19 swept across the nation, most major retailers have started placing orders again, but still are not offering supply chain financing to their vendors. To make matters worse, many of them have also increased their payment terms from net 30 days to net 60 days or even net 90 days, forcing their vendors to wait even longer to get paid. Prior to the pandemic, extending payment terms was sign of financial distress and imminent bankruptcy, although this year we believe that it is simply a response to the unknown as stores may have to close again should things become worse. It is possible that supply chain financing may one day be offered again by retailers, but at this point, it is very clear that it is not a reliable way for wholesalers to finance their business. Another recession, or even worse, another pandemic, could easily result in the disappearance of supply chain financing again.
The disappearance of supply chain finance as an affordable way to finance a small business has led to a huge increase in demand for accounts receivable factoring. Factoring is a lot like supply chain finance, except instead of being initiated by the retailer, it is initiated by the wholesaler. It also does not require the approval of the retailer; it is solely at the discretion of the wholesaler as to whether they wished to work with a factoring company. Therefore, wholesalers don’t need to worry as much about when the next disaster will hit, the financing that their business needs is completely within their control.
Factoring also provides access to funds 7-10 days faster than supply chain finance. Where retailers typically need to receive merchandise and check it into their system prior to making an offer of early payment to their vendors, factoring companies are willing to fund their clients the same day they ship their merchandise to their customers. That means even better cash flow than you would have received with supply chain financing.
Furthermore, if non-recourse factoring is offered, then the wholesaler also receives credit insurance on their receivables along with the improved cash flow that they receive. However, unlike credit insurance companies, factoring companies have access to real-time data that shows orders placed and payment trends, along with the data that credit insurance companies receive from credit reporting agencies. As a result, factoring companies can oftentimes approve accounts that a credit insurance company may not feel comfortable with.
Accounts receivable factoring is also available on any and all accounts that a wholesaler may sell to. Where supply chain finance is typically only available from major retailers, and credit insurance comes with minimums and deductibles that pretty much rule out smaller receivables from being insured, factoring companies are willing to work with customers of all sizes. A wholesaler who does half their business with major retailers, and the other half with small mom-and-pop shops, would have access to immediate funding and credit insurance on their entire portfolio if they choose to work with a factoring company, whereas before only half their portfolio would have had financing and insurance available.
The cost of accounts receivable factoring is very comparable to the cost of supply chain financing, and in all likelihood is much less than the cost of supply chain finance and credit insurance combined. Like supply chain financing, factoring fees are based on a percent of an invoices value, however that rate is fixed so you know exactly what to expect every time you factor an invoice and can easily build it into your pricing. With supply chain financing the percentage can change based upon the retailers needs at the time they offering early payment. If a retailer begins to struggle, or if they simply need access to working capital to fund an expansion, they can ask for larger discounts in exchange for early payment.
Credit insurance on the other hand works like any other insurance product, you pay an annual premium based on how much volume you expect to do at the beginning of the year. Larger volumes get you better rates, but you don’t get reimbursed if your sales don’t reach your expectations. Likewise, if your sales exceed your expectations you may find yourself having to purchase additional coverage at a higher rate than had you purchased more coverage in the first place. Even when there isn’t a pandemic, guessing the correct amount of coverage to get can be tricky, while the pandemic pretty much guaranteed that any companies with credit insurance way overpaid for coverage. Since factoring is based on a fixed percent of an invoices value, you only pay for what you insure, nothing more, nothing less. You also don’t need to worry about deductibles or minimums with factoring, if your factoring company approves your customer, then you are fully insured.
Accounts Receivable Factoring is one of the oldest forms of financing and not only has survived many recessions, but has also been available throughout recessions and this current pandemic. Here at DSA Factors we have been providing factoring for over 30 years and have survived several recessions during that time period. There is no question that the COVID pandemic has been the most difficult event that we have had to deal with, but we never stopped providing financing to our clients, not even in April when things were at their worst. However, we aren’t only continuing to fund our clients, we are also accepting new clients and offering them the same great service that we provide to all of our clients. If your business has lost the financing options it had been relying on for the past few years as a result of the pandemic, please give DSA Factors a call today at 773-248-9000. We are ready and willing to provide you with the funds you need to keep your business going!