Payment on credit is incredibly common and across the UK, the total value of B2B credit is around £437 billion (Finder, 2021).
Despite the ubiquity of credit, it does have its drawbacks. Around 1 in 10 invoices in the UK are paid late and small and medium businesses in the UK are owed an estimated £34 billion in late payments (Market Finance, 2019), which has a huge impact on the stability of their accounts receivables.
With that in mind, making sure you and your clients offer the appropriate amount of credit to customers and having a system in place for assessing whether they are able and willing to make payments on time is essential.
To help put this in place we’ve summarised key guidance on setting credit limits here, as well as creating a full PDF guide on how to set credit limits for business-to-business payments - this can be used by your firm or by your clients.
Credit checking customers
The first step in establishing credit limits should be running a credit check on your potential customers’ business - ideally, this should be part of your due diligence when onboarding a new customer.
This provides vital information on their business’ payment history, current revenue, and outstanding obligations - giving you greater insight into whether to offer them credit.
As outlined in detail in our credit limits guide, in order to run a business credit check, you’ll need certain details from your customer during the onboarding process, including:
- Signed consent to conduct credit checks with the customer's bank, credit reference agencies, and their trade suppliers.
- Details of the business owner.
- The specific legal status of the business.
- The businesses address.
- Their bank account details.
- If the company is a limited company, you’ll also need their business registration number.
- The exact amount of credit being requested.
- Full contact details for whoever deals with your customer’s finances.
Our recommended way to obtain these details is to create a business credit policy (you can use this template) and as part of the process, require customers to fill out a business credit application. Customers refusing to provide this information should be considered a red flag.
Selecting the right credit limit
Once your credit check is completed and you’re assured it’s viable to offer this customer credit, you need to select an appropriate credit limit for them.
There are two important external factors you need to consider when doing this:
- The context of the application: Are they a long-standing customer with a history of prompt payments and placing large orders? If so, it pays to be generous. Are they a new business - or have you had payment issues in the past? Start with a low limit and adjust later.
- Your firm’s risk appetite: This is your willingness to risk credit you’ve extended not being paid back. A greater risk appetite can mean attracting new customers and getting larger orders from existing clients - but this needs to be balanced with keeping acceptable limits to avoid bad debt, and will depend on your business’ circumstances.
What to base credit limits on
Effective credit limits are always based on hard numbers, and there are few ways to determine the credit limits you should set.
See a full breakdown of each method below and example cases in this free guide to credit limits.
- Net worth calculation
- Trade References Model
- Days Sales Outstanding
Credit risk management
Credit limits should not be set in stone. When your customer’s payment behaviour changes, you should be able to notice this promptly and adapt their credit limits accordingly.
The key to managing this effectively is easy-to-access data and reporting. A comprehensive credit control tool, like Chaser, allows you to draw on insights generated from the payment behaviour of your customers.
Compare customer payment behaviour to their historic data to identify any significant changes that may require an adjustment in their creditworthiness. If you have access to this data, you can use it as the foundation for any future credit decisions. View a summary of red flags to look out for when monitoring credit risks in this guide.
See further guidance on credit limits including how to best adjust your credit limits over time and ensure ongoing effective credit control in this free PDF guide: How to set credit limits: a guide for business-to-business payments:
Alternatively, see how you and your clients can automatically set, track, and monitor your customers' credit limits with ease with Chaser during a 20-minute webinar:
Chaser provides accounts receivable software and credit control services that lets users get invoices paid faster without losing the human touch. Chaser is Xero’s highest-rated receivables platform, and can now be connected with all accounting systems. Chaser works directly with SMEs and partners with forward-thinking accounting and bookkeeping firms to improve theirs and their clients’ receivables processes.