Setting customer credit limits that are appropriate for both parties is a crucial part of ensuring you don't get into financial trouble or jeopardize professional relations.
Setting credit limits for your customers can be a delicate balancing act. You don't want to be too severe as this may tarnish a valuable professional relationship and discourage them from spending large sums with you. On the flip side, allowing them to have too much flexibility can jeopardize your company's own revenue stream and even push you into financial trouble.
There are ways you can reduce the risk to your business when setting credit limits for clients by identifying which customers may be better options, and which red flags to look out for.
Run business credit checks
Business checks are a key part of deciding when it's wise to allow a larger level of credit and which clients will require very strict limits or even no payment flexibility at all.
Newer companies may struggle with this as they may not have had time to establish credit scores or ratings for their organization. In these cases, you can use other methods to decide whether or not to allow them a low, high or medium credit limit. This may be talking to other suppliers, asking about their collateral, or setting strict limits to begin with and then making them more flexible as you gain confidence.
Establish a credit policy
Creating a business credit policy makes sure customers are held accountable for any debt they have with you. This normally involves asking for references from customers and the bank, as well as financial statements.
Again, newly established organizations may struggle to provide you with financial statements but should be able to supply personal documentation and references. It's perfectly acceptable to deny credit to a company because they don't have the financial documentation to support it, just ensure you have a policy to refer to and set your guidelines accordingly.
Balance the numbers
Looking at a variety of figures from the company can help you determine how to define your credit relationship. Net worth calculation, days sales outstanding (DSO), as well as any references, can all be useful in allowing you to decide where to set the credit limit for a particular customer.
Know the red flags
There are certain red flags that can tell you when you need to be wary of allowing credit. Delays in payment, a sudden change in orders, and poor correspondence can all be alarm bells when it comes to credit limits. In this instance, you should keep an eye on the client and if it continues, tell them you will have to reduce the current credit limit.
Each country has key regulators that a business needs to file information to, and inform should they fall into bankruptcy. Doing a little research in this area can give you a good snapshot of how an organization is faring financially.
For US-based companies, accounts are usually filed at a state level, compared to the national Companies House in the UK, which can make the matter a little more complicated and time-consuming if you need to check multiple businesses from different countries. However, records like D-U-N-S numbers are international and can give you a good idea of how a business is performing.
Judge the risk
Extending any level of credit comes with a certain amount of risk, but these steps can help you to reduce it. Most calculations of credit scores rely on past performance, which provides no guarantee for the future so it's important that you use your own judgement.
You should also ensure no personal feelings come into your credit limit decisions. Data should be used to help guide your decision but you should make sure it's purely a business decision. You need to establish this with all clients from the start to maintain your own financial health.
It's possible for suppliers or clients to be great to work with but if they don't pay you on time, they're not the type of customer you should be comfortable allowing a credit limit.
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