How much credit to allow your customers
- buy an opinion from a credit agency
- get a decision from a credit insurer or:
- make your own calculation.
To set your own Credit Limit, there are two approaches:
- 1 A Credit Limit to support sales levels. If references are good enough, the Credit Limit = twice the monthly sales figure for that customer.
- 2 A maximum amount you are prepared to be owed, regardless of current sales levels. A popular calculation is the lower of 10% Net Worth or 20% Working Capital (Net Current Assets).
Method 1 needs constant revision as sales increase but is a useful trigger for re-checking the risk at intervals. Method 2 is better as sales staff have the authority to sell up to the Credit Limit, which needs less frequent revision.
How about a Risk Code?
As well as the amount of credit, a risk code can indicate the likelihood of being paid late and therefore how closely you need to watch the account. For example:
- A = (No Risk) - those with the best credit references and payment records
- B = (Average)
- C = (High Risk) - those who have become slow payers or have county court judgments against them.
- N= (New) - customers you have traded with for less than six months.
Code C identifies persistent slow payers, county court judgments, markedly worse solvency. Insolvencies will then come as less of a surprise and all should be from the C category.
Despite the risk, you may have to take on some C accounts if you can't get enough business from A's and B's. There is good profit to be had from C's if you monitor them carefully and minimise your risks.
If you identify your C customers, you can put extra sales effort into the A's and B's in future to put your business on a sounder footing. But remember to review these codes over time.
Make sure your staff are aware of customer credit limits.