Offering your customers the option of lines of credit as a payment method is a great way of opening up new business opportunities.
Payment on credit is incredibly common for small and medium enterprises (SMEs) and, across the UK, the total value of B2B credit is around £437 billion.
However, despite the ubiquity of credit, it does come with its drawbacks. Smaller businesses are far more reliant on cash flow to survive and late payments continue to be a massive issue.
Around 1 in 10 invoices in the UK are paid late and small businesses in the UK are owed an estimated £34 billion in late payments, which has a huge impact on the stability of their accounts receivables.
With that in mind, making sure you are offering the appropriate amount of credit to customers who are able and willing to make payments on time is essential.
To help you put that level of effective credit control into place, we’ve put together this quick guide to setting credit limits.
Credit checking potential customers
Your first step in making sure you’re setting effective credit limits is credit checking your customers. This is such an important step that we’ve included it in our credit control and debt collection policy template for businesses.
When negotiating with potential customers, you should be asking them to fill out a credit checking form that authorizes you to reach out to banks, credit referencing companies, and trade organizations to check the validity of your customer’s ability to pay on time.
This doesn’t need to be an uncomfortable conversation. Given the scale of B2B credit, asking for these kinds of details in order to conduct credit checks is a standard part of effective credit management.
Your customer should be entirely willing to submit to a credit check and refusal is definitely a red flag.
The details you’ll need to collect to get full credit references include:
- Signed consent to conduct credit checks with the customer's bank, credit reference agencies, and their trade suppliers.
- Details of the business ownership.
- 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.
These details should be enough to allow you to conduct a thorough credit check on your potential customer before you offer them any lines of credit.
Credit checking new customers
In certain circumstances, especially if you’ve just started your business, you might want to start taking orders as fast as possible and leave the credit checking process till later.
If that is the case, you should start with smaller, more manageable credit limits, between £500 and £750.
Going forward, you can use the 80/20 rule to identify the customers that are most important to your business and prioritize credit checking them, so you can offer them more impactful levels of credit.
If possible, you should eventually get round to credit checking all of your customers. This will allow you to focus your attention and efforts on those customers who are the least likely to default and who pay you in full and on time.
What is the 80/20 rule?
The 80/20 rule is a business mantra that recognizes that the relationship between input and output is almost never balanced.
The idea is that, since 20 per cent of your work produces 80 per cent of your results, you should focus as much effort on that 20 per cent as possible.
The same rule can be applied to your customers.
Those rare customers you’ve built a strong working relationship with, put in consistent large orders with you, and who pay on time, should be the focus of the majority of your efforts.
Implement ongoing monitoring
Economic circumstances are always subject to change. That’s a lesson that’s been brought home hard over the last year. Given this, it’s normally not enough for you to just credit check your customer’s once.
You’ll want to put in place a regular schedule for credit checking your customers and monitoring their payment behaviour.
Chaser’s centralized hub allows you to track all of the accounts receivables information in one place. You can then use our range of interactive reports to understand your customers’ payment behaviours and gain insight into your aged receivables.
Tracking your payment information is a great way to get an advanced warning of a change in your customer’s financial status, such as sudden changes in payment habits or an increase in late payments, and you can then implement additional credit checks from there.
Credit checking customers: information sources
Alongside banks, trade suppliers, and credit score agencies, there are a number of publicly available sources of information on issues that might impact your customer’s credit rating. These include:
- Companies House - Companies House incorporates and dissolves limited companies and makes information about those companies available to the public.
- The Insolvency Service - The insolvency service manages business and personal bankruptcies and has a publicly available list of any individual voluntary arrangements and bankruptcies.
- The Northern Ireland Courts and Tribunals Service - The NICTS keeps publicly available records of all Enforcement of Judgments Office cases related to defaulting on payments.
Setting levels of customer credit
When it comes to setting a credit limit for your customers, there are a few important factors that can form the baseline of your credit policy:
Using credit reports
Once you’ve obtained all the information and permissions you need to access a credit report from a reputable credit reporting agency, you can use that report as the basis for setting a credit limit.
An effective credit report will provide you with a range of analytics that you can use as part of establishing your appetite for risk, observing customer purchase patterns and predicting the potential for business failure.
Rather than obtaining just one of these reports when onboarding a customer, using them to get regular check-ups on your customer’s financial health is a good way to enact a holistic approach to credit control that stimulates business growth while protecting your company from undue risk.
Setting your appetite for risk
Risk, in this context, is how much credit you are willing to offer a customer based on the information you have about their financial situation.
Establishing your appetite for risk, at its most basic level, involves comparing your customer’s credit score to the impact it would have if they defaulted on the amount of credit you are offering them.
You’ll also need to establish a cohesive risk policy that is shared and understood throughout your business. The last thing you want is miscommunication between departments or staff members resulting in a customer being offered two different levels of credit.
Having a comprehensive risk policy in place which emphasizes due diligence and personal responsibility means far fewer costly mistakes.
Understanding customer purchase patterns
If a customer requests a change in their credit limit, which is quite a common occurrence, understanding their purchase patterns is vital to assessing the impact that increase could have on your risk.
Using Chaser’s centralized hub, you can track all your customer’s payment habits to get a fuller understanding of why they are requesting a change in credit. If they have recently become less reliable in terms of paying in full and on time, this could be a red flag.
However, if they have remained consistent and punctual in their payments, they may simply be looking to increase the amount they can order from you.
Having this information at your fingertips, in an easy-to-access format is vital to effective credit management.
Understanding your own limits
So far, we’ve spoken a fair amount about setting credit limits based on the behaviour of your customers. However, it is also important to take into account your own company’s financial health.
Keeping static credit limits in place can have a negative impact on your business if they don’t reflect changing economic conditions.
Maintaining a more flexible approach to setting credit limits, based on your business’ performance, can help you increase your growth or reduce your risk.
