How Accounts Receivable Put Options Minimize Your Risk
Accounts Receivable Put Options is a product that can offer your company protection on 100% of each invoice amount in the event that your customer, a publicly traded company, declares bankruptcy a credit risk management tool that can address the ever-increasing concern that vendors have about their customers’ credit quality and financial stability.
Under credit insurance, coverage is normally available on a significant pool of customers within the portfolio that are creditworthy; a put option can be tailored for one specific customer, usually a publicly traded company (private companies can also be underwritten), and will assume the bankruptcy risk whether that customer is investment grade or highly distressed.
Although from time to time coverage of an account may be canceled under credit insurance, there is no risk of cancellation of the put option. In addition, when a bankruptcy occurs, the full amount of the outstanding receivable is paid very timely without any deductibles, co-insurance or set offs. Instead, under credit insurance, payments are normally made 30 to 60 days after the claim filing less deductibles, co-insurance or the salvage value of the goods in the transaction.
How it Works. You plan to invoice your customer for $100,000 on June 1, 2013 with payment terms for 60 days. You also continue to invoice every month for about $100,000, which means that at any point time in time your customer will be owing you about $200,000.
Based on this scenario, you may wish to buy an Accounts Receivable Put Option for at least six months, perhaps out to one year, with a face value of $200,000. Each month there is a premium – in this case, it’s 1% of the face value – $2,000 per month for 6 months, which comes to a total of $12,000. If, during the option period, your customer declares bankruptcy, you will be paid the entire value of the receivable up to $200,000 by the financial entity that sold you the put option.
In short, Accounts Receivable Put Options:
- have market driven pricing and in a strong economy the price is quite competitive to credit insurance,
- cover the creditor in the event of bankruptcy only, and
- are usually purchased on companies that are publicly traded or on sizable private companies where there are audited financial statements.
Although no-one would have imagined that Chrysler and GM would have gone bankrupt in 2009, as our economy continues to sputter along, there are hundreds of publicly traded companies in serious financial condition. It is with this scenario in mind that an Accounts Receivable Put Option will have tremendous risk mitigation value.