Meaning
Financial risk measure representing the total value of goods or services delivered to a customer for which payment has not yet been received. Monitoring trade credit exposure involves tracking the balance of outstanding invoices against the approved credit limit for each buyer.
Risk Concentration
Excessive reliance on a small number of large customers increases the vulnerability of the supplier. If trade credit exposure to a single client exceeds twenty percent of the total receivables, a single default can jeopardize the liquidity of the business. Management uses aging reports to identify which portions of the exposure are overdue.
Diversifying the customer base helps to spread this risk across different industries and regions.
Limit Assessment
Credit departments set the maximum allowable balance for each account based on financial statements and payment history. Increasing the trade credit exposure for a customer requires a formal review of their current cash flow and debt obligations. This limit acts as a ceiling to prevent the supplier from taking on more risk than it can afford.
Default Consequence
Unpaid invoices are eventually written off as bad debt if collection efforts fail. High levels of trade credit exposure lead to higher insurance premiums for credit protection. The cost of carrying these receivables includes the interest on the money borrowed to fund the production of the goods.
