Questions and Answers
What is the preferred type of guarantee from the seller's viewpoint?
What is required of the seller in a guarantee of collection or performance?
What is a potential issue with a small business owner personally guaranteeing a payment?
Why might a personal guarantee be appealing to a seller?
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What can be a useful alternative to a personal guarantee from a small business owner?
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What is a potential advantage of a third-party guarantee?
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What should be requested when researching the possibility of a third-party guarantee?
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Why might a seller require a personal guarantee from a new business customer?
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What is the primary goal of credit risk reduction techniques?
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Why is credit risk important?
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What is the main purpose of payment guarantees?
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What is credit risk?
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What is the benefit of using a mix of credit risk reduction techniques?
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What is one way to retain ownership of goods?
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Who can provide a payment guarantee?
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What is the result of offloading ownership of an invoice?
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Study Notes
Credit Risk Reduction
- Credit risk reduction techniques can significantly reduce bad debt for a company.
- Effective risk reduction alternatives allow a business to issue a large amount of credit to customers while minimizing receivables risk.
What is Credit Risk?
- Credit risk is the risk of loss due to a borrower's failure to repay a loan or meet contractual obligations.
- Credit risk is a major risk faced by banks and other financial institutions, impacting their financial health and stability.
Classification of Risk Reduction
- Find alternative payer: someone besides the customer becomes liable for payments or pays insurance for bad debts.
- Retain ownership: retain legal interest in goods sold to recover them in case of default.
- Offload ownership: transfer ownership of an invoice to a third party in exchange for cash, transferring default risk.
- Pay early: a mix of these tools can achieve significant bad debt risk reduction.
Payment Guarantees
- Main sources: owner of a business, a corporate parent, fellow subsidiary, or a third party.
- Two types of guarantees: Guarantee of Payment and Guarantee of Collection/Performance.
Guarantee of Payment
- Preferred type from the seller's viewpoint.
- Seller can protect payment from the guarantor without first attempting to collect from the buyer.
Guarantee of Collection/Performance
- Requires the seller to first attempt to collect from the buyer, then pursue collection from the guarantor.
Owner of a Small Business as Guarantor
- May be willing to personally guarantee payment using personal assets.
- Problems with this approach:
- Owner's net worth may be closely tied to the business's fortunes.
- Owner may have issued personal guarantees to many suppliers.
- Demanding a personal guarantee may not foster long-term loyalty.
If Business is a Subsidiary
- Obtain a payment guarantee from the parent company.
- Parent entity may have more assets, making it an excellent backup payer.
Guarantee from a Third Party
- May be a related party with an interest in the buyer's operations.
- Assets of a third party may not be closely tied to the buyer's fortunes.
- Request documentation of the third party's net assets and preceding guarantees.
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Description
Learn how to reduce credit risk and minimize bad debt recognition. Understand the importance of credit risk management and its alternatives in business.