Things to Consider When Setting and Communicating Credit Limits

woman on the phone in officeCredit limits serve a variety of purposes. Companies can use them as a guideline for order approval, to minimize the upward spiral of orders or to call immediate attention to a change in a customer’s purchasing or payment behaviour.

Often the tendency is to let the credit limit simply become a matter of course, which means that a company approves any order the customer places. This basis for credit decisions should be reserved for only very substantial and financially sound customers. Consider the following information when working with credit limits:

Setting Limits

Credit departments can automatically approve orders that do not exceed an established limit. Orders that do exceed limits signal a need for further investigation or analysis of the account and could cause a firm to halt shipments to the customer until the situation has been resolved. A formal analysis might set a credit limit high enough to eliminate the need for a review every time a new order is received.

A credit limit is established without regard to the size of any order and is generally set at an amount that can be justified by the available credit information. In addition, some companies place an order limit, which specifies the dollar amount that may be released without delay on any single order.

This usually serves as a secondary credit check, so the customer’s file is reviewed when either the credit limit or order limit is exceeded. An order limit may be particularly useful in a decentralized credit organization where it is impractical for order processing points to keep complete records of receivables.

One variation of the credit limit is based upon the amount that the creditor is willing to have outstanding at any time. This method requires complete records of unpaid invoices and of orders approved but not yet shipped. When the total outstanding balance exceeds the limit, any further orders are referred for approval.

Communicating Credit Limit Decisions

Many companies advise their sales department of the credit limits assigned to customers, often expressing the limits in terms of units (300 tons, 20 carloads) or dollars allowed during a given period. If, for example, a customer has a credit limit of R5,000 on terms of 1/10, net/30 and consistently discounts, this customer could be sold from R10,000 to R15,000 per month. Because of discount payments, the highest credit would still be expected to remain within the credit limit of R 5,000.

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Informing Customers of Credit Limits

There is considerable debate as to the advisability of informing customers of their credit limits. There is no law or regulation that requires such compliance. Of course, a credit grantor cannot discriminate when approving credit, and certain rules apply whenever an adverse action is taken either upon approval or after the account has been established.

In some companies, the credit limit is the maximum amount that will be shipped to the customer before initiating a review of the credit file for that customer. In other companies, it is simply the maximum amount that will be shipped to the customer before that amount is paid down or paid in full. The particular definition depends on the creditor’s policy regarding credit extension. There are distinct advantages and disadvantages of advising customers of credit limits. The decision to advise or not to advise is dependent on each creditor’s company policy and management philosophy.

Some companies prefer not to establish a firm credit limit, opting instead for a flexible limit based on previous experience with the account. Flexible limits have the advantage of being easy to implement with little impact to the customer and the sales department. Unless payments are not made on time, there may be little need for further involvement at the credit department level. Those who favor a more formal system of establishing credit limits point out that the account may become overvalued quickly. Prompt payments may be a buildup for later—and larger—unpaid orders.

How To Deal With Late Payment

Every day, we hear from business owners who have to cope with long payment terms and late payments. Periods of market uncertainty – for example, the recent Eurozone crisis and Brexit – often trigger a push by large companies to lengthen payment terms. Everyone wants to hold onto cash longer and get paid quicker.

So here are our top 5 tips to help you deal with late payment

1. Know Your Customers

It may be a cliché but it pays to have a good relationship with your client or a representative of that business. That way it’ll be easier to sort out payment terms and chase any overdue payments. Just always make sure you don’t let any frustration at a late payment sour these relationships. Small business owners can’t risk offending their biggest and most important client by ringing up and being terse with the person on the other end of the phone.

2. Agree Payment Terms In Advance So You Can Control Your Cash Flow Management At The Source

By agreeing invoice payment terms in advance, you can pre-empt cash flow fluctuations and decide on something that suits your business growth plan. Consequently, you’ll be better prepared. Of course, some blue-chip customers will insist on extremely long payment terms that are standard across the business.

If entering into a relationship with exceptionally long payment terms – 90 days is not unusual with supermarkets or high street retailers, for example, a common tactic for improving cash flow is to start a relationship with an invoice discounting facility, or negotiate a price discount in exchange for faster payment terms. This way, you trade some of your profit margin for prompt, reliable payment, but do be careful to assess different options.

Many large customers will ask for rebates for early payment of invoices – if these are 5% or more, you will need to weigh this up with the cost of monthly funding – as this might be a cheaper alternative.

3. Invoicing Correctly and Promptly

Anything that slows the payment process or distracts from it could lead to serious problems. Organisation is paramount, as is putting the correct payment terms on invoices.

The faster that the billing department generates invoices and sends them to the customer after a product or service is delivered the sooner payment will be received. As obvious as this may be, too many companies will perform such work in batches, and it may take them a week or more to invoice their customers. Electronic invoicing and payment tools can further speed up the payment process.

Invoicing errors are a frequent contributor to long payment cycles. Quoted prices might not match up with master data, and invoices might not include the all-important purchase order number, which leads to an invalidated invoice that might be disputed by the customer. Analysis of such errors can uncover the failures that are driving mistakes. Simplifying payment terms and controlling other sources of complexity can limit the opportunities for error.

4. Chasing Payment Immediately When It Becomes Overdue

Obviously, you need to be paid for the service/product you have provided so make sure that you respond swiftly and efficiently if a payment becomes overdue. Remember, heavy-handed attempts at collection and enforcement (especially by third parties) can often backfire on your relationship with your client, so be sure to be considerate with your late payment terms.

For small companies which have a relationship with large corporates, this kind of negotiation can be very delicate. Often, late payment of invoices is down to an error in some labyrinthine department that your regular contact has no access to within a huge matrixed organisation. Often, you will be dealing with the procurement or buying department and have less of a direct relationship with the accounts payable department. Try to solve things through your regular contact, rather than going over their head and encourage them to talk to relevant staff in payments.

One of the worst steps a small business can take in this situation is to attempt enforcement action when chasing payments, for example, by trying to levy statutory interest on an overdue invoice. That can often turn the finance department against you, and they may switch to another supplier rather than deal with the hassle.

5. If You Deal With Vendor Portals Make Sure You Know How They Work

A recent trend for large corporations is to implement online vendor portals where suppliers can log on, submit their invoices, and check the status of upcoming payments. It is very important that suppliers know how this system works and understand the right process for accepting purchase orders, issuing invoices, and inputting correct payment bank account details.

Often these portals are designed to cut out human interaction and help desks might be difficult to reach (and often based overseas). So, it is important that you take the time at the start to understand the protocol, avoiding any delays when you are dependent on receiving the cash to meet your own bills. No one likes a last-minute dash.

Contact PATC Today

PATC offer a number of professional services, including bookkeeping, business plans, payroll services, investment advice and more- contact PATC today for assistance with credit limits.

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