Accounting Best Practices, Fifth Edition

7–40. Obtain Credit Insurance

Letters of credit take time to set up, are difficult to monitor, and must be followed to the letter in order to be paid. This process makes smaller companies less than willing to enter into international sales. Also, companies of any size may be unwilling to grant large lines of credit or even smaller ones if customers have some risk of nonpayment. In both instances, a prudent credit manager may recommend dropping a potential sale.

An increasingly common solution to this dilemma is the use of credit insurance. This is essentially a guarantee against customer nonpayment. It is faster to set up than a line of credit, can be used for both domestic and international receivables, and allows a company to increase its credit lines to customers. Also, for those companies willing to take on some credit risk themselves, they can extend a larger credit line than the credit insurance company may allow, thereby giving themselves the opportunity to earn additional revenue. Further, a company using credit insurance can reduce the size of its bad debt reserve, as well as offer a higher-quality accounts receivable base as collateral for a line of credit. Credit insurance is available for domestic credit, export credit, and coverage of custom products prior to delivery, in case customers cancel orders.

If a credit insurance policy stipulates a maximum credit limit per customer, the insurance company must make the decision to increase the credit limit, or the company ...