A/R put option pricing is calculated in terms of months of coverage, multiplied by amount of coverage.
- Contract of 3 months’ worth of coverage
- $1,000,000 coverage limit
- Rate of 0.75% (per month)
- All-in cost would be: $22,500
- Why? 3 x $1,000,000 x 0.75% = $22,500
- Contract for 6 months’ worth of coverage
- $100,000 coverage limit
- Rate of 1% (per month)
- All-in cost would be: $6,000
- Why? 6 x $100,000 x 1% = $6,000
Here are two key concepts with A/R put option coverage:
1. Coverage limits: in general, A/R put option contracts will cover the A/R exposure, up to the stated coverage dollar amount, at the time of the customer financial default.
- Vendor ShoeCo. Ltd. has $300,000 in coverage on Buyer SneakerWorld Inc.
- SneakerWorld Inc. is forced into a Chapter 7 bankruptcy. At this time, ShoeCo. Ltd. has open A/R to SneakerWorld in the amount of $700,000
- The A/R put option contract is triggered by SneakerWorld’s Chapter 7 bankruptcy, and pays out $300,000 to ShoeCo. Ltd., as this is the coverage limit
- Vendor ABC has $500,000 in coverage on Buyer XYZ (per the A/R put option contract)
- One day, XYZ goes bankrupt, triggering the A/R put option contract. As of this time, ABC has open receivables of $300,000 due from XYZ
- The A/R put option contract will pay out $300,000 (remember, generally there is no co-insurance or deductible)
2. Coverage time frames: in general, coverage is valid from contract start date, until contract end date—and the customer bankruptcy event must occur between these two dates in order to be covered! In other words, the coverage attaches to the date of the bankruptcy, not the date of invoice.
- Vendor ShoeCo. Ltd has an A/R put option contract with a start date of July 1st 2016 and an end date of July 1st 2017, with $1,000,000 in coverage on their buyer SneakerWorld
- On June 20th 2017, ShoeCo. has open A/R due from SneakerWorld of $550,000 and they make another sale on June 25th 2017 of $125,000—bringing their total open A/R to $675,000
- On July 8th, 2017, SneakerWorld is forced into bankruptcy
- Unfortunately, ShoeCo. is not covered in this case, as the contract expired on July 1st, 2017. To avoid this case, ShoeCo. should have either purchased a contract extension, or made sure their A/R exposure was brought to (or close to) zero by July 1st, 2017, until they had another risk mitigation solution in place
- Vendor ABC has an A/R put option contract with a start date of January 1st, and an end date of June 30th, covering its A/R exposure to Buyer XYZ
- On June 14th, Buyer XYZ bankrupts
- Vendor ABC will be covered under the A/R put option, up to the amount of open A/R, not to exceed the coverage limit
How to figure out what you need:
Once you’ve decided that an A/R put option could be a good fit, you’ll want to review a quote. In order to figure out what you need:
- Calculate your current A/R exposure.
- Consult with your sales team to determine your likely upcoming orders.
- Know your sales terms.
- Determine what your likely open A/R exposure will be for each of the upcoming months.
- Consult with Export Safe to determine what structure can most closely match your needs.
Assume that you will have the following upcoming sales:
- Month 1: $300,000
- Month 2: $350,000
- Month 3: $100,000
- Month 4: $50,000
- Month 5: $450,000
- Month 6: $75,000
- Assume you sell on net 60 day terms
- Assume you want coverage for the coming 6 months
Note that coverage is generally only possible in increments of $50,000. In the case above, while the company estimates to have $525,000 in open A/R during month 6, it has decided to go with $550,000 rather than $500,000 in coverage, in order to be on the safe side (see two cells outlined in red). Notice that month 7 is shaded in a different color, as that exposure will not be included in this particular contract. In practice, it is a good idea to include a "tail" month or two to the contract, in case the buyer pays later than expected.
In practice, of course, buyers do not always order on the first of the month, and pay on the last day of the month—nonetheless, the above worksheet is a “tried-and-true” method for many vendors who use A/R put options.
Here at Export Safe we're experts in A/R put option solutions. Please contact us for quotes and/or more information.
Each A/R put option contract must be read and evaluated individually. You should always read the full contract, and seek legal and financial advice from a trusted advisor before engaging in any contract.