How to set a credit limit
If your business is thinking about lending credit to a new company, then there are many factors to consider before you go ahead and dole out the cash. Lending credit always comes with a certain amount of risk so it’s important you know as much about the company you plan on lending to as possible. In short, deciding to lend credit to a new company is never going to be a flash in the pan decision. It takes time and serious thought.
Once you’ve decided you are willing to lend credit to a prospective company, you’re now in the tricky business of working out how much to lend. Working out how to set a credit limit all comes down to the background information you’ve found on the company you’ll be dealing with.
The major factor to consider is how likely the company is to be able to repay the credit you’ve loaned. You’ll have gathered information which will give you a good insight into the probability of this during your evaluation of the business so far. This evaluation should have taken the form of a credit check using one of the well-known credit checking agencies. Data gathered by these sources is up to date, reliable and thorough so you can rest assured that there’ll have been no fiddling with figures here.
As well as using credit checks to understand any potential credit risks the company you’re looking into may have, you can also use references. Ask the company to supply you with trade references – or alternatively ask their permission to contact businesses they have had past dealings with. If the business is a new company, this of course won’t be possible – but lending credit to a new business should be done with extreme caution anyway.
Always double check
Unfortunately, not everyone you come in to contact with is altogether honest. Credit checks are a great way of double-checking whether what a company says is true, is actually true. If you’ve got any question marks looming, go with your gut instinct and check – especially if you encounter the following.
- This new business says it’s been around for ages but you’ve never ever heard of them. If you’re in the same industry and you’d have thought you would have heard of them,
then check. A questionable start date is a sure-fire sign something could be amiss.
- They supply you with all-singing all-dancing trade references. If these references aren’t from businesses within your industry, make sure you follow them up as the company could be trying to pull a fast one.
- Run a check on the directors of the company. If they’ve been involved in past failed businesses, or they’ve got CCJs on their files, it’s clearly not the wisest move to start dishing out credit.
- The business has a super-flashy name which sounds incredibly impressive. ‘Worldwide Technology Solutions Inc’ may sound as if they’ve got cash to spare, but what’s in a name? Just because it sounds good, doesn’t mean it necessarily is – nearly everyone can string a few words together to create a business name so never go on a moniker alone.
The amount of credit to lend
Lending credit isn’t just a one-way concern. Yes, you’ve got to consider how quickly the company you’re lending to will be able to pay you back, but you also have to evaluate how much outstanding credit you can afford to expose yourself to. The amount of credit to extend may also depend on whether they are habitual slow payers - how to manage slow payers.
Companies fall into two categories: high risk and low risk. Lower risk businesses are those that have paid past credit back on time, met invoice dates, and whose credit checks point to the all clear. Higher risk customers are obviously the opposite and should be lent to with more caution. If you do decide to lend to a business that hasn’t got a credit history that’s squeaky clean, you’ll need to set conservative limits. It’s common sense, but you should consider shortening the credit terms and lending less than you may ordinarily. If, after a while, the business proves itself capable of meeting payment deadlines and you’re happy with the way things are going, you can of course review the credit limit.
As with most things in life, at the start of a new business arrangement, it’s always best to err on the side of caution. Carry out thorough checks, evaluate the risk your company can manage, and act accordingly. Once you've followed these steps, you should be in a much better place to decide how to set a credit limit.