Credit limit
The maximum balance a business allows a customer to owe on credit at any one time.
In short
- It caps how much the business can lose if that customer never pays.
- Limits are set from credit checks, payment history and the size of the relationship.
- Orders that would push a customer over the limit are usually held for review.
A credit limit is the ceiling on what a customer can owe. When a business sells on terms like net 30, it is lending the customer the value of the goods until they pay. The limit decides how much it is willing to lend.
How limits are set
- Credit information: reports from credit bureaus, bank references and trade references from other suppliers.
- Financial statements: for larger accounts, the customer's own financials.
- Payment history: how reliably the customer has paid in the past.
- Expected volume: a limit should cover normal orders over the payment period, plus some margin.
Using limits day to day
When a new order would take a customer's balance, including unpaid invoices and open orders, over its limit, the order is usually flagged. The credit team can release it, ask for payment on overdue invoices first, request a deposit or raise the limit. Customers who are over their limit or have invoices past a set age are often put on credit hold until they pay.
Limits need regular review. A customer whose business has grown may need a higher limit to keep ordering; one that has started paying late may need a lower one before the balance becomes a bad debt.
Worked example
An order held at the limit
A contractor has a $50,000 credit limit and owes $41,000, of which $12,000 is more than 30 days overdue. It places a new $15,000 order. That would take its balance to $56,000. The order is held. The credit manager calls, the contractor pays the $12,000 overdue amount, and the order ships the same afternoon.