Abstract: Trade credit alleviates the shortage of a downstream firm’s capital and increases the order quantity, but also aggravates the financial risk of suppliers. One strategy for a supplier to mitigate the downstream firm’s default risk is enhancing the recovery rate by exerting efforts, such as establishing customer credit management system, or negotiating mortgage clause, or improving customer relationship to change the priority of being repaid. Factoring the accounts receivable based on the guarantee of trade credit insurance can also reduce the trade credit risk. Considering a single-period sales model, this paper investigates how a supplier with financial constraint should choose and establish an effective strategy of managing trade credit risk. Based on the model, the influence of working capital on the supplier’s choice, the optimal effort level, and the optimal coverage limit, are analyzed respectively as well. By the numerical analysis, the paper further explores the impact of order quantity and default rate of a downstream firm on the values of the factoring and the optimal coverage limit.The findings indicate that when facing severe financial constraints, suppliers should prioritize ensuring retailers’ income without default rather than blindly investing high costs to mitigate credit payment risks. Credit insurance is not an effective means to reduce credit payment risk when initial funds are abundant or scarce. However, if combined with factoring services, credit insurance can enhance investment returns through advances provided by factoring services, thereby increasing its value. When the security factor for insurance is low and prepayment yield is sufficiently high, full insurance becomes the optimal strategy. In such cases, suppliers no longer need to rely solely on their own efforts to improve payment recovery rates.

Key words: trade credit risk, trade credit insurance, factoring, financial constraint