Tuesday, April 1, 2014

The Quick Guide to Setting Appropriate Credit Limits

Credit limits can be a bit of a prickly question, particularly following 2008's terrifying credit crash. How much is too much? How much is irresponsible? How low becomes restrictive and starts to eat into potential profits? It can be a complicated minefield. For companies who are not sure how much credit to allow individuals or businesses, we've put together a quick guide to setting appropriate credit limits which protect your business from defaulted payments, keep your clients from financial trouble and ensure that you don't put the dampeners on potential growth.

Everyone's different
It may sound simple but this is an important consideration to take into account when setting credit limits. Every client you take on is different, with different financial situations, different needs and different patterns of behaviour. Taking a closer look at each prospective client on an individual basis is an important way to get to grips with where their individual credit limit should be.

Many businesses set blanket credit limits, but a quick look at a sample of businesses in just one industry using RM Online's free company checking tool shows that there are radically different financial situations to contend with and, more importantly, varying degrees of risk to protect against. By showing a company's financial position, recording non-payments and CCJs and disclosing any legal issues, this tool clearly demonstrates why careful research needs to be conducted before credit limits are set.

Categorise your clients
It can help to segment your customers on the basis of your findings and research. Take a wide-angle view of the businesses you offer credit to and consider their similarities and differences. If possible, group them into categories ranging from the high risk to the low risk. If you can build profiles around each group then you can create different credit limits which fit each group, minimising how much work must be done to decide on each business's credit limit. If you will be delegating the setting of credit limits to staff, this process can be very helpful, particularly if it can be condensed into a short series of questions i.e.:

  • What is the the company turnover?
  • Does the company have any outstanding invoices?
  • Has the company been flagged for non-payments?
  • Has the company been given a CCJ?

Define your goals
If you have a clear idea of the effect you want to achieve with your credit limit, you can tailor your policy to help make it happen. For instance, if you want your customers to feel confident and spend more, higher credit limits can encourage bigger spends. Meanwhile if you are particularly vulnerable to non-payment, lower credit limits will provide peace of mind and ensure clients only have access to credit they can easily afford. The overall goal for most businesses will be to give low risk clients the freedom to make the most of your services and ensure high risk clients have structures in place to avoid slow or non-payment.

Monitor trends
This is an ongoing process and it is important to keep a close eye on the effect of your credit limits. Watch for emerging trends and focus on things like slow payment, delayed payment and customers who repeatedly hit their upper credit limit and consistently pay on time. Evaluating the effects of your limit over time will help you to find the perfect system which protects both your business and your clients, while giving low risk customers the freedom to help your business grow.

What is your approach to setting credit limits for your customers? Do you use a blanket approach or do you invest time and resources in tailoring limits to particular customers? Share your thoughts and experiences with our readers below.

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