Last October, the daily newspaper 24 Heures informed us that nearly 2,800 Swiss companies went bankrupt between January and September of 2020 (according to a study by the firm Bisnode). Although these bankruptcies took place in the midst of a global health crisis, they are due to multiple factors, particularly delays and defaults in payments by third parties, a major financial risk known as “del credere risk.”
What is del credere risk?
Origin of the term “del credere”
In finance and in law, the del credere obligation makes an intermediary jointly and severally liable for his client’s debts, as it relates to a particular transaction. This obligation generally results from a signed contract, and it encourages the intermediary to wait until his client provides sufficient guarantees of solvency before finalizing the sale.
The del credere obligation can, in some cases, give rise to risk, insofar as the intermediary is not always able to verify his client’s true level of solvency, which can quite naturally vary over time…
Noteworthy: Although they share a common origin, del credere liability and del credere risk are actually two distinct concepts.
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Definition of del credere risk
By definition, del credere risk refers to when a buyer refuses to pay or becomes insolvent or when a buyer’s guarantor becomes insolvent. Del credere risk is therefore implicit in every sale of goods and services on credit. It is also called “commercial risk.”
If a company, whether in the public or private sector, immediately delivers services and goods while the buyer is given several weeks or even months to make payment, that company is exposed to a late payment risk, or in the worst-case scenario, a non-payment risk.
Del credere risk threatens a company’s financial health because it disrupts cash flow, even more so if a significant portion of its sales are exposed to del credere risk.
Indeed, del credere risk is very much present in B2B, that is, when companies supply other companies. Since B2B orders are much larger than in B2C (when companies supply individual consumers), it is very common for companies to give their customers payment terms ranging from 30 to 90 days…
Of course, large companies with a comfortable cash flow can afford some exposure to del credere risk. However, the self-employed as well as small to medium enterprises (SMEs) are particularly exposed to default or late payment by customers because they have a very low tolerance for cashflow shortages.
The different types of del credere risk
Self-employed people and companies selling goods and services on credit are exposed to three main types of del credere risk, namely:
- Late payment risk. A risk that may seem minor initially—a delay in payment of only a few days has little impact on a company—it can cause significant difficulty and expense if it goes on longer—a delay of several weeks or more requires an entire dunning process and creates a dangerous lack of liquidity for the company.
- Refusal to pay risk. Very harmful for the company, this risk includes all situations where the customer refuses to pay for the goods and services purchased, regardless of the reason for refusal. This results in a significant loss of profit for the company, in addition to having to implement and engage in lengthy and costly procedures (collections, lawsuits…).
- Insolvency risk. This is when the customer is unable to honor its debt to the company, for example because of a one-time financial problem or perhaps even bankruptcy. Here again, the loss of profit can be substantial, and repayment can take a very long time or might even be impossible to obtain.
How do you protect yourself against del credere risk?
Forgo sales on credit
Del credere risk is inherent in selling goods and services on credit. It can only be totally avoided by simply staying away from this type of sale. Stop selling on credit! In fact, requiring payment before delivery of goods and services—as is always the case in e-commerce, for example—is a way to protect oneself against del credere risk.
Purchase credit insurance
However, it is possible to protect oneself from del credere risk while still giving payment terms to customers. Purchase credit insurance.
There is insurance specifically designed for SMEs, to insure against non-payment of goods and services sold on credit. If non-payment can be established, the company will be compensated according to the terms of the insurance policy.
The terms and conditions of credit insurance can vary widely depending on the situation. They generally take into account:
- the risk profile of the client;
- the type and cost of goods and services sold on credit
- the cost of insurance and the coverage desired by the insured.
Noteworthy: Some credit insurance policies even cover against the risk that documents critical to getting paid for goods and services delivered were not reduced to writing or have not been recorded.
Hire a specialist
Furthermore, some companies resort to specialized services to cover against del credere risk. Specialists usually suggest comprehensive coverage, including credit insurance (which already offers good protection), invoice financing, and even collections services in cases where non-payment can be established.
This solution offers personalized coverage, adapted to the company’s needs and allows you to leverage the service of experts.
Finally, another option available to eliminate del credere risk, is to assign your receivables to a third party. In this case, ownership of your customer’s receivables is transferred to a third party, in which case you are paid a sizable portion (more or less) of the amount initially invoiced to your customer, depending on the probability of recovery estimated by the buyer of your receivables.
To summarize, del credere risk is the risk of non-payment by the buyer in connection with a sale on credit. If not properly managed, del credere risk can quickly spell TROUBLE for self-employed people and SMEs with insufficient liquidity.