Five Reasons you Should Set Customer Credit Limits and Stick to Them
In an ideal world your business would be paid in full before any goods or services exchange hands, however, this is an unrealistic ideal for competitive businesses. Subsequently offering credit to your customers is an ideal to maintain a competitive advantage; there are, however, risks involved in offering credit and therefore we would highly recommend your implement Customer Credit Limits.
Why should you use customer credit limits within your business?
They are necessary for many trade credit insurers
Not so much a reason, but a requirement for many trade credit insurers is to set a credit limit, and often they may take some control over what the credit limit will be dependent on the financial standing of the customer and their ability to pay.
They encourage customers to pay quicker
A credit limit can act as a great form of leverage, for your customer to remain under their credit limit it will be necessary to make more frequent or higher value payments to bring them below their credit limit.
I must add that this only acts as a great form of leverage when you stick to your credit limit; if you highlight to your customers that you will allow them to go over their credit limit, they will not see this as a viable threat to encourage them to make payment.
They limit the amount of potential bad debt you could be exposed to
If you limit the amount of credit your customer can have without payment then you potentially limit the amount of money that can turn into bad debt. If no credit limit is set, then you could potentially find their credit rising and rising, without receiving payment, and subsequently the worst was to happen you are left with a much greater value of bad debt than you would if you had cut the credit off at a lower amount.
They enable you to implement a credit hold function for late payment or reaching credit limit
This must be in your terms and conditions, and you can indeed implement this without having credit limits, but in my opinion it is a much more effective form of leverage when credit limits are applied. Having a credit hold function in your terms allows you to stop any goods or services should there be issues of late payment, or if your customer reaches their credit limit without payment to bring it down.
The costs associated with offering credit
There are substantial costs involved in offering credit to your customers in interest, bank fees, staff costs of chasing outstanding debt, especially when late or non-payment occurs. By having a credit limit you potentially reduce these costs by using your credit limit as leverage and getting paid quicker.
There is a balance between giving a customer too little credit & too much. You don’t want to restrict sales but you should keep your exposure to bad debt to a minimum. Therefore it’s useful to have a documented methodology of setting credit limits that is adhered to. Business is about risk, but we strongly recommend risks should be known and evaluated.
Download our free guide on how much customer credit could be costing your business.
