Economic uncertainty increases cash flow risk for suppliers

A slowing economy, changing consumer patterns, increasing debt servicing costs, and tight margins are impacting the financial health of all businesses regardless of size. If their payment discipline declines, this can have devastating consequences for suppliers.

Tough economy driving insolvencies

It’s a difficult time for business. For some time, high inflation, labour shortages and growing wage costs have placed significant pressure on profit margins. More recently, rising interest rates have caused further financial trouble for firms. As of August 2023, the Bank of England had imposed 14 consecutive increases in interest rates, with the market anticipating another increase next month. For businesses, these rising rates have dramatically increased the cost of debt servicing. This, in turn, is forcing record numbers of businesses across sectors into administration.

Businesses in the retail, wholesale, and food and drink sectors have been impacted harder than others, not least due to their exposure to supply chain pressures, significant energy usage and often highly leveraged business models. According to research conducted by law firm RPC (opens a new window), insolvencies of retail businesses have jumped 56% in the past year alone, to what is a decade high. There were a total of 1,942 insolvencies in the 12 months ending April 2023.

Meanwhile, beverage manufacturing saw a 136% increase (opens a new window) in the year ending February 2023, with a total of 66 insolvencies. The food production sector fared even worse, with insolvencies nearly tripling to 173 over the same period, up from 64 – the biggest rise among major industries.

Payment schedules threaten suppliers

The threat of insolvency is likely to affect businesses all along the supply chain. For those able to withstand the pressure, there are opportunities to be had – not least, the possibility of growing market share where competitors have failed. But there are dangers, too.

Manufacturers and suppliers of goods – from food produce to clothes garments – typically sell their products to customers and distributors on credit, often with delayed payment terms of between 30 to 90 days. As those customers increasingly enter into financial difficulty, and possible insolvency, there is a growing likelihood that they will be unable to fulfil those credit agreements to their suppliers. Once again, this risk is exacerbated amid a high interest rate environment, which has seen the cost of credit increase.

But the economic landscape is not the only pressure on such customers; suppliers’ own financial pressures, and the strategic decisions they take, may also push buyers of goods towards insolvency. To prioritise their cashflow amid a tightening economic environment, many suppliers may opt for shorter payment schedules. Although this ostensibly acts to safeguard the supplier from difficulty, it can have the opposite effect. By amplifying cash flow issues for the buying customer, the risk of default can increase, again threatening suppliers with a potential shortfall.

The much-publicised recent demise of a value retailer (opens a new window) is one such example. The firm experienced cash flow difficulties following a deterioration in trading during both the pandemic and recent cost of living crisis. Its collapse into administration was then confirmed following at least one insurer’s withdrawal of trade credit insurance. This caused suppliers to pause and reduce deliveries, leaving the retailer with a stock shortage.

Global supply chain challenges are also amplifying the trading risk. To avoid disruption, and in an effort to reduce their carbon emissions, many firms are turning towards near-shoring of suppliers (opens a new window). But while this may allow firms to bypass some risk, it also introduces new challenges, including amplifying pinch points within the supply chain. Likewise, the onboarding process for new suppliers has the potential to throw up unexpected difficulties, with disruptive consequences for trading.

Trade credit insurance – payment protection (and beyond)

For suppliers looking to mitigate against the risks of buyer default, one option is to take out trade credit insurance. This type of cover offers protection – subject to policy conditions – against the risk of a customer being unable to pay for goods or services provided on credit terms. The level of cover required is requested by the policyholder based on their anticipated exposure.

The benefits of trade credit insurance may also extend beyond the protection of non-payment, to include:

  • Giving businesses the confidence to extend credit to new customers who might otherwise be deemed too risky, particularly those overseas (where risks may be greater)

  • Improving access to funding, often at more competitive rates, as it will increase banks’ willingness to lend to an insured customer

  • Ongoing monitoring of the policyholder’s customers, and assignment of credit limits based on those customers’ specific risk exposure (this limit provides the amount of protection the insurer will offer should the customer fail to pay)

  • Providing policyholders with access to an information network – this effectively serves as an early warning mechanism, with the insurer informing the policyholder of any changes that might impact the financial health of their customers, and their ability to pay for delivered goods or services

  • Risk mitigation planning advice

To maximise the opportunities afforded by trade credit insurance, existing policyholders should adhere to several fundamentals of best practice. These include the need to report accounts within policy timeframes, as failure to do so may impact upon the validity of a claim. Likewise, actively encouraging customers to share information with insurers will give underwriters greater confidence to extend credit lines to a given firm, which is particularly critical as economic uncertainty increases. Individual credit limits and Insurers Maximum Liability (IML) should also be kept under constant review, to ensure they sufficiently cover a firm’s exposure to its customers.

The importance of proactive risk mitigation

Amid the growing likelihood of a default or insolvency scenario, it’s wise for suppliers to take mitigating steps to protect their business. Trade credit insurance is one option, but it is not the only means at firms’ disposal. By closely monitoring the end consumer market, suppliers may be able to forecast changing trends ahead of time, enabling them to proactively reduce their exposure, such as by targeting new clients in a less exposed sector.

Similarly, suppliers should leverage existing relationships to develop insight into the financial health of their customer base. Engaging with customers to establish trust and facilitate dialogue around cash flow and payment difficulties will allow issues to be flagged early, and enable potential solutions to be found. By building out this information at scale, suppliers can use it to direct their broader business strategy.

For further information, please visit our Retail Practice Group (opens a new window) and Food and Drink (opens a new window) pages, or contact:

Nigel Birney, Head of Trade Credit

T: +44 (0)289 034 8322

M: +44 (o) 7917 107441


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London Market Insurance Update H1 2024