Thomas Miranda is audit senior manager at Friedman LLP, an accounting and advisory firm that works with businesses throughout New Jersey.
Tightening margins, increased pressure for faster inventory turnaround, and a rise in e-commerce competition are a risk for businesses, particularly those who manufacture apparel or consumer goods. We asked Thomas what business leaders can do to continue serving larger customers who face credit or bankruptcy risk.
A factoring arrangement lets your company assign its receivables as collateral to a lender and immediately obtain a significant percentage of the receivable value in cash. Certain factoring arrangements can also transfer the risk of collectability from your company to the lender, and may provide credit insurance on the receivable if your company maintains the risk of collectability.
Buying credit insurance on your receivables acts as a hedge in the event a customer becomes unable to pay their receivable or goes out of business. Depending on the insurance policy, a claim may cover significantly all of the uncollectible receivable balance. However, buying insurance comes with costs that need to be evaluated when determining the benefits and security it provides. Additional costs to consider are premium costs and deductible limits.
If your customer’s credit is not being approved by your lender, this could be a red flag that their credit risk has increased drastically. In the event you want to continue fulfilling the customer’s orders, ask them to provide your factory with a letter of credit. The letter acts as a guarantee of payment once the merchandise is delivered as negotiated. If a letter of credit is not an option, ask for a cash deposit upfront. The deposit should be enough to cover your production costs and continue the relationship.