Top 5 Factors to Consider When Setting Credit Limits for Your Business

Setting credit limits is a key aspect of credit risk management, helping businesses minimise financial losses, comply with regulations, and maintain stability. 

Assessing customer creditworthiness and adjusting limits strategically enables businesses to manage credit risk effectively, extend credit wisely, and balance risk with growth. Regular reviews and advanced analytics further refine credit strategies, ensuring long-term financial health. 

This article covers: 

• The top 5 factors to consider when setting credit limits 
• Methods of Setting Credit Limits  
• Common challenges businesses face in credit limit management 
• How Cedar Rose can help your business manage its credit risk strategy
   

The Top 5 Factors to Consider When Setting Credit Limits  

After conducting a business credit check on a B2B client and determining that it’s viable for you to offer them credit, the next step is to set the right credit limit for them. 

Here are 5 key factors to consider when setting credit limits.  

1. Creditworthiness Assessment 

A thorough credit assessment is essential for effective credit risk management, ensuring customers have the financial reliability to meet their obligations. This involves analysing balance sheets, income statements, and cash flow to assess stability, profitability, and liquidity. Reviewing payment history with both your company and other suppliers helps determine reliability. Additionally credit reports from reputable bureaus provide standardised insights, including credit scores, credit utilisation, and debt-to-income ratios. 

2. Business Stability and Industry Risk 

A company's longevity and reputation significantly influence its credit risk. Established businesses with strong track records generally present lower risks than newer, less-proven entities. However, industry conditions are equally important, as economic downturns and market volatility can affect a customer's ability to meet obligations. Evaluating both business stability and broader industry trends allows for more informed and strategic credit decisions.  

3. Transaction Volume and Frequency 

The expected sales volume and transaction frequency directly impact credit limits and play a critical role in credit risk management. Higher sales may justify larger limits but also increase exposure to risk. Frequent transactions might require higher limits to support smooth operations. Striking a balance between maximising sales and managing financial risk is essential to maintaining a sustainable credit policy. 

4. Relationship and Customer History 

Long-standing, positive relationships foster trust and can support credit decisions, but objectivity is key. A customer’s payment behaviour and growth potential provide insights into their future financial stability. Evaluating past interactions ensures a well-rounded approach to credit management. 

5. Internal Policies and Risk Tolerance 

A clear credit policy is fundamental for consistency. It should define assessment criteria, risk capacity, risk tolerance, and procedures for handling payment issues. Aligning credit limits with a company’s risk strategy helps mitigate potential losses while maintaining financial stability. 

Methods of Setting Credit Limits 

Once your B2B client is considered eligible and the above factors are considered, you can calculate credit limits via one of the below methods: 

• Trade references: Check a client’s past payment history through trade references and industry partners.
  
• Net worth calculation: Set a limit based on a percentage of the customer's net worth determined by subtracting total liabilities from total assets. A common benchmark is 10% net worth to ensure financial stability and manage credit risk. 
  
• Needs-based calculation: This method considers the customer's specific requirements and extends credit based on their operational needs to establish a strong and sustainable business relationship. 

Since each method produces different figures, it’s best to calculate all three and take the average for the appropriate credit limit. 

After setting the credit limit, the next step is choosing the appropriate type of credit account. Instalment accounts allow customers to make purchases and repay in fixed amounts over an agreed period, ensuring transparency with a clear repayment schedule. Revolving accounts provide a flexible credit facility up to a set limit, allowing borrowers to reuse credit as they repay, provided their account remains in good standing. Vendor accounts, also known as trade or supplier accounts, enable businesses to defer payments for goods or services, typically within 30 days. Vendor accounts help establish trust between businesses and their customers. However, there is a risk of misuse by the borrower, so it is important to implement safeguards to protect against potential abuse. 

Common Challenges Businesses Face in Credit Limit Management 

Setting appropriate credit limits for financial institutions or B2B clients is a complex process that comes with several challenges. One major challenge is assessing creditworthiness, as businesses often rely on historical data that may not accurately reflect a customer's current financial position. This can result in credit limits that are either too restrictive, hindering sales, or too lenient, increasing the risk of bad debt. 

Adding to this complexity, dynamic economic conditions such as inflation, shifting market demand, and geopolitical events can impact a customer’s ability to meet obligations. Businesses must monitor these factors and adjust credit limits accordingly, which requires significant resources. At the same time, balancing risk and opportunity is important. While extending credit supports sales, excessive limits increase financial exposure, whereas overly cautious limits can weaken customer relationships. 

Another challenge is data limitations, particularly for SMEs that may struggle to access reliable credit information. Incomplete or outdated data can lead to poor decisions, while new customers with little or no credit history present added risk. Inconsistent credit policies across departments or branches further complicate credit management, leading to confusion, inefficiencies, and a potential loss of customer trust. 

Businesses must also comply with regulatory requirements, ensuring they meet industry and regional standards while effectively managing risk. Compliance often requires additional resources and ongoing oversight. Moreover, monitoring and adjusting credit limits is essential, as a customer’s financial stability and payment patterns change over time. However, many businesses lack a structured review process, increasing financial exposure. 

Finally, customer relationship management plays a vital role, since enforcing credit limits can sometimes create tension, especially if clients perceive them as overly restrictive. Clear communication and flexibility help maintain strong business relationships. At the same time, technological integration can improve credit management but presents challenges. Many businesses struggle to align new systems with existing operations, leading to disruptions and data inconsistencies. 

How Cedar Rose Can Help Your Business Manage Its Credit Risk Strategy  

Cedar Rose helps your business actively mitigate and manage credit risk with confidence. 

Using advanced tools like the CR Score, ASI, and ACL algorithm, powered by our CRiS Intelligence platform, we deliver comprehensive, data-driven insights. Our solutions empower your business to make informed credit decisions, prevent financial losses, and build strong financial partnerships.  

Reach out to us to discover how we can help you confidently manage your credit risk strategy.

Sources:

1. https://ncri.com/how-to-set-credit-limits-in-accounts-receivable-management/  
2. https://www.creditguru.com/index.php/credit-management/commercial-credit-management-articles/40-how-to-set-credit-limits   
3.  https://www.allianz-trade.com/en_CA/insights/understanding-b2b-customer-credit-limits.html  
4. https://www.creditmanagement-tools.com/set-up-the-credit-limit-c2-r21.php  
5. https://www.linkedin.com/pulse/art-science-setting-credit-limits-nacm-national/  
6. https://www.linkedin.com/pulse/what-b2b-customer-credit-limits-how-do-work-harsh-baid/