How to Set a Credit Limit

What a credit limit really is

A credit limit caps the total a customer can owe you at once, across all unpaid invoices. It is not a measure of how much you like the customer — it is a measure of how much you can afford to lose if they fail to pay, weighed against the trade the relationship brings in.

Set limits too low and you frustrate good customers and lose sales. Set them too high and a single insolvency can take a serious bite out of your working capital. The aim is a number that lets profitable trade flow while keeping any single failure survivable. Every active credit customer should have a limit on file, even if it is generous.

Three ways to calculate a starting limit

Pick whichever fits your information:

• Expected trade method: estimate the customer's likely monthly purchases and set the limit to cover one to two months on your terms.
• Affordable-loss method: decide the most you could comfortably write off from one customer, and cap the limit there.
• Reference method: ask for trade references and set an opening limit in line with what other suppliers already extend.

For a new customer, start conservative and let a clean payment record earn increases.

Factor in your own cash position

A limit that is prudent for a well-capitalised business may be reckless for one running tight on cash. Before you finalise a number, look at your own debtor concentration: if this one account would represent a large share of your total receivables, scale it back regardless of how creditworthy the customer looks.

A useful sense-check is the late-payment cost. Model what a slow-paying balance at this limit would do to your cash flow using the late payment calculator. If the answer makes you wince, the limit is too high for your circumstances.

Reviewing limits over time

Limits are not set-and-forget. Raise them when a customer has paid cleanly over several cycles and is asking for more capacity. Cut them — or move to stop-supply — when payments slow, cheques bounce, or you hear of trouble in their market.

Schedule a quick review of your top accounts each quarter. For the mechanics of escalating a new customer's limit in stages, see staged credit limits for new customers. Keeping limits current is one of the cheapest forms of credit risk control you have.