Entrepreneurs understand how to fund and manage traditional facilities like bank loans and overdrafts, invoice discounting and asset-based finance. But, less considered are a range of other finance sources known as ‘soft credit’. These can be vital to running a business, but their value can be hidden from view as they don’t appear anywhere in a balance sheet. Unfortunately, out of sight can often mean out of mind in terms of risk management.
What is covered by the term soft credit?
Trade credit insurance
In its simplest form, trade credit insurance provides protection to a company’s suppliers against its failure. Without it, supply chains cannot function well as most suppliers will either refuse to do business without it, or they will use up a business’s working capital resources by demanding cash on delivery.
Credit card processors
So much trading is done now online, while many bricks and mortar businesses have gone card only. The credit card processors transfer the payment receipts to the merchant. However, through this process, they know that they will take the first hit on returns, non-deliveries, customer disputes and fraud. When in doubt, credit card processors will reduce or defer settlements to build up reserves against these problems if the merchant fails and cannot see them right.
These feature in a wide range of business scenarios. Examples are: Performance bonds in the construction sector, travel bonding arrangements and trade guarantees for international business. Without these facilities, contracts will not be won, travel businesses cannot operate and exporters are unable to function.
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What businesses are at risk with soft credit providers?
After a challenging 2022, when corporate failures were at their second highest ever level, soft credit providers across the board are gearing up for a significant further rise in insolvencies this year. Because of this, soft credit providers are already adjusting and restricting cover, or withdrawing facilities for individual companies and for certain sectors, which they deem to be at greatest risk.
This is why EY Parthenon’s recent UK company profit warnings focus on the impending soft credit issues business are facing.
The result of cuts in soft credit facilities
Previous financial crises have shown that cuts in a company’s soft credit facilities can very easily leak across into core lending relationships and affect its ability to raise new money. It can even lead to going concern issues with auditors because of the risk to overall liquidity. This is why mitigating soft credit risks should be a top focus for business owners in the current economic climate.
Business owner tips for mitigating risk
- Quantify your exposure to soft credit to gain clarity on your business’s risk. Then make sure this is included in your regular financial monitoring. This will highlight any potential soft credit issues before they become a serious problem, giving you good time to resolve them.
- Consider what relationships with soft credit providers you could strengthen. These relationships are often much weaker than with other funders, such as banks. But opening up contacts and lines of communication early will serve you well going forward.
- Once established, maintain a regular dialogue with you providers. Communicate regularly relaying good news as well as outlining and explaining any setbacks to pre-empt potential issues.
- Have an action plan that you can quickly implement if issues with providers arise.
- If you are ever unsure about a soft credit issues, it is best to get advice early. Talking to an independent specialist, who understand the various soft credit markets, can help in providing an impartial review your soft credit exposure, identify weaknesses, assist with negotiations, find alternatives where necessary and add credibility to interactions with providers.
How we can help
We have extensive experience in working with businesses to provide advice and facilitate financial and legal arrangements and we will always work with you to find the best solution for you and your business.
One of our Partners would be more than happy to have a non-obligatory confidential chat with you. We can be contacted at email@example.com or call us on 020 3326 6454 and we will arrange for a call with one of our Partners.