liquidated damages clause

Michael Dennis from Covering Credit recently published an article titled: “Is Credit Insurance the “Silver Bullet?” The article, responding to a company in the B2B space who suggested that bad debts can be avoided with the purchase of credit insurance, discusses some reasons why credit insurance is not a “silver bullet” in the credit management space.

I agree.  But, at least with respect to the construction and material building supply industries, I disagree with Mr. Dennis’ ultimate conclusion that “bad debt losses are inevitable for companies.”  Here is why.

Credit Insurance Is Of Little Use To Avoid Bad Debts

Mr. Dennis makes three great points about credit insurance in his article: (1) Credit insurance is usually not available on high-risk accounts; (2) There are deductibles and minimum loss thresholds that minimize its usefulness; and (3) Policy limits restrict recovery.

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In fact, Mr. Dennis draws on his own personal experience to shoot down the utility of these policies, saying that in the past ten years of working with a company that has credit insurance, “the costs associated with credit insurance [was] offset by the recoveries” in only one of those years.  In my view, they were lucky that year.

The points made in this article are spot-on about credit insurance.

While this credit tool may have some application under certain circumstances, it’s definitely not a first line of defense. Credit insurance is like insurance of almost any other character: it’s there to avoid an enormous loss.

Is Bad Debt Inevitable?  No.

This leads me to the second part of Mr. Dennis’ article which suggests that companies cannot avoid bad debts and write offs unless they are “too” conservative in accepting risk.  Bad debt and write-offs are, in other words, a fact of life in business.

I agree that risk is an inevitable part of any successful business, and I agree that great credit managers are interested in taking more business – and therefore – accepting more risk. A couple of months ago I wrote a post called the “Three Traits Of A Great Credit Manager” and I alluded to this very same “risk is inevitable  philosophy:

The company can’t take more business if it does so at too high of a risk. Nevertheless, so-so credit managers don’t seem to mentally put this picture together. Great credit managers know that getting more business is job one, and they are constantly examining their policies and systems to see if there is a way to open the door to folks more often, and not less often.

But, if risk is inevitable, doesn’t that mean bad debt and write-offs are inevitable?

In the construction and building material supply industries the answer is No, and that’s because of the mechanics lien and bond claim laws.  The mechanics lien and bond claim laws were invented more than 200 years ago precisely to eliminate credit risk in the construction industry, and they have been adopted in every state.

These laws are very, very effective.  Of course, they are not perfect and there is still a tiny risk of loss, but they are nearly perfect if used correctly.  For more information on how using mechanics lien protections can turn the credit problem upside down for the collections and material supply industries check out this White Paper:  What To Do When Your Customer Doesn’t Pay On Time.

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