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Set up the credit limit

When a seller make a sale to a buyer with a payment term, he grants a loan to its customer. This loan will be resorbed only after bills are paid.

The credit limit is the maximum amount of loan that the seller accepts to grant to its customer.

It depends on:

  • the assessment of creditworthiness that you previously made. See Credit notation,
  • your customer's financial capacity,
  • the commercial stakes,
  • the payment term negociated,
  • the expected volume of the business.
how to calculate a credit limit
 Set up a credit limit for each customer. If credit limit is reached, you will need to renegotiate the payment terms to limit your risk with your client.
 Credit limit does not mean limit of orders. Negotiate advance payments, establishment of additional guarantees (bank guarantees, delegations of payment, credit insurance ... etc) to maximize your sales while controlling the risk of bad debts and improving your working capital.

What is a Credit Limit?

The credit limit corresponds to the maximum credit risk that the supplier agrees to take on a particular client.

The credit risk includes the accounts receivable (invoices including taxes + other receivable) and the backlog (orders in hand not yet invoiced).

  • My DSO Manager

    Credit limits management in My DSO Manager

    Use the credit limit set up tool included in My DSO Manager.

    It is based on business requirements and customizable financial criteria.

    My DSO Manager includes a workflow to validate credit limits according to approbation levels.

    Then, use the risk report and alerts to manage credit risk and outstanding receivable compare to the credit limits of your customers accounts.

    The software provides with all indicators required to assess the credit limit and the risk. See more with the online demo.

The criteria used to set up credit limits and the level of risk acceptance should be consistent with your company's credit management strategy. Do you have a policy of strong commercial development, even assuming risk of non-payment or do you want to preserve the profitability of your business above all?

Why is it needed to set up a Credit Limit?

Set up a credit limit for each customer is mandatory. The credit granted to customers is similar to a financial loan. Set up a credit limit ensures that the amount of this credit is consistent with the financial capacities of each customer.

Set up credit limits is one of the key tools to avoid overdue invoices and bad debts.

How set up a credit limit?

First step is to collect information about your customer:

  • Business expected:
    • Amount of sales expected with the client,
    • Period (in months),
    • Payment term considered,
  • Sales Manager feedback:
    • Key customer or not?
    • Position on the market, growing business?
    • Reliable or not?
  • Legal and financial information about the customer:
    • Last profit and loss accounts and balance sheet,
    • Company legal form,
    • Date of creation,
    • References from other suppliers,
    • Payment behaviour.
  • Customer visit: When the business or the credit risk stakes are high, it is needed to visit the customer to:
    • Get fresh information about customer’s financial situation,
    • Create a personalized contact with the customer,
    • Negotiate financial conditions of the business (payment terms, payment guarantees, schedule of payment...etc.)
Second step is to calculate the required credit limit:

The required credit limit is the business need of credit limit. It is the product of the estimated sales to come, the schedule of invoicing and the payment term granted to the customer.

Required credit limit can be challenged by negotiation with the customer

Third step is to set up the Credit Limit:

Once required credit limit is calculated, it must be compared to the information collected about legal & financial situation of the buyer, and its payment behaviour.

The Credit Limit has to be consistent with financial capacities of the customer and its payment behaviour.
There are several ways to set a credit limit. Each has advantages and disadvantages.
We have created an innovative method which first includes in the calculation the required credit limit related to your volume of orders and payment terms negotiated. Then the tool (Excel file to download or online tool) compares the amount obtained with the result of the credit ranking (obtained with the credit notation tool) and financial capabilities of your customer.
Main criteria are:

Equity in order to compare the credit limit with stable financial resources of your client.
Tangible Net Worth to ensure that the credit limit is proportionately consistent with the intrinsic financial value of your buyer.
Debt providers to ensure that you do not pass from the position of single creditor to the principal funder of your client, especially if the credit exceeds what has been invested by shareholders and bankers. By becoming a primary supplier, you can make your customers dependent on the credit granted.
Turnover. The credit limit should be very significantly lower than the turnover of your client. Be careful to the proportion of credit limit amount / company size of your client.
Operating income. Compare the credit limit to the operating income of your client. It should not exceed 50% of the operating income.
Once credit limits are set up, they must be regularly reviewed:

Economical context is changing very fast and it will change faster in future. It is the same for the financial situation of your customers.

Then, every credit limit has to be reviewed at least twice a year or every time the buiness relation is changing (overdue invoices, new orders, negative or positive information obtained about the customer...etc.).

Conclusion

The set up of credit limits for each of its private customers is necessary to manage the customer risk and limit its commitment according to buyer's capabilities.

Another advantage, this practice pushes salespeople and other managers to negotiate better terms of payment with customers because it allows to make more turnover.

This practice is therefore very beneficial for the company to develop its business while improving its WCR and limiting its exposure to the risk of bad debts.

Even customers can find their interest because some will be happy to negotiate a down payment or an advance payment against an attractive discount.


Next: set up the payment term
 

Online tools:

Credit limit calculation

Tools download:

Credit limit set up tool based on the business need and financial capacities of your customer.

This tool is a big help for credit analysts to ensure credit limits are coherent with customer financial situation.
Two tools in one with the Credit notation tool linked with the Credit limit set up tool.

This tool is the most powerful to set up a credit limit according to business need and financial situation of your buyer.


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Last comments

EHAB - 21/12/2017
I have downloaded the Credit limit set up file. it is really good work, however , some field i found it not really clear. for example and i am refering to the excel sheet: what is the meaning of "Duration of the period in months" in C7. is it the means the period of the sales to be finish like delivery date ? in the Customer Date section in the Balance sheet , what is the Suppliers debt is it the Liabilities ? and what is the "Turnover" meaning in Profit and loss , I7 ?
Hello,
Duration: this the period on the sales value you enter.
Suppliers debt is Account Payable value
Turnover is the sales.
Hang Dinh
Thank you for the quality of the tools!
Hang Dinh
Thank you for the quality of the tools!
VINOD
Great job. Really like it.
Tran Tien
Every credit limit has to be reviewed at least twice a year or every time the buiness relation is changing (overdue invoices, new orders, negative or positive information obtained about the customer...etc.).
Hao D V
Very interesting, helpful website!
Lydia Golveo
Very helpful
Katerina Kostovska

I am interested to learn more about credit limit set up and credit control of my buyers.
You can download the tool "credit limit setup" to learn more about this essential analysis.

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Your site has an astonishing clarity. Well done!

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