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What a credit limit actually controls
A credit limit caps the total value of unpaid invoices you will allow to accumulate for a single customer at any one time. It is not a limit on how much the customer can order over a period — only on how much can remain outstanding. Once a customer's live receivables reach their limit, new orders should be held until they pay down the balance.
Setting limits per customer forces a deliberate risk decision on each account rather than allowing exposure to creep upward unnoticed. For many SMEs, the top five customers represent a disproportionate share of revenue and receivables — concentration risk that should be reflected in your limit-setting.
Frameworks for calculating limits
There is no single formula, but common approaches include:
- Bureau-guided — use the credit bureau's recommended limit as a starting point, adjusted for your commercial judgement
- Percentage of their net assets — e.g. limit exposure to 10% of the customer's most recently filed net asset figure
- Monthly spend cap — set the limit at one to two months' expected monthly spend, so the customer must pay regularly to keep ordering
- Tiered by relationship age — new accounts get a lower limit; it increases after 6 and 12 months of prompt payment
Whatever method you use, document the rationale for each limit and who approved it. This is essential for audit trail and for insurance purposes.
Reviewing and adjusting limits
Limits should be reviewed at least annually, and immediately if: a customer requests a significant increase, their payment behaviour changes, they file accounts showing a materially weaker balance sheet, or adverse intelligence reaches you (redundancies, key management departures, supplier rumours).
When a customer requests a higher limit, treat it as a new credit application. Ask for updated financial information, re-run your bureau check, and obtain new trade references if the requested increase is material. Approve, adjust, or decline in writing.
Credit insurance and limit alignment
Trade credit insurance policies indemnify you against bad debts on approved buyers up to a policy limit per buyer. The insurer sets their own buyer limits based on their assessment — which may differ from yours. If the insurer's limit on a customer is lower than your internal limit, your insurance will not cover the excess.
Review your insured limits regularly and notify the insurer promptly of any material changes in customer status. Credit insurance can also serve as a second opinion: if the insurer declines cover on a prospective customer, treat that as a significant red flag. Confirm specific policy terms with your broker.
Frequently asked questions
Should credit limits be communicated to customers?
You are not obliged to disclose the limit itself. However, your terms should state that you reserve the right to place accounts on hold if the balance exceeds your approved credit threshold. This avoids the customer claiming ignorance if you stop supply mid-order.
What happens if a customer exceeds their limit?
Your standard process should require manager approval before processing orders that would take a customer over their limit. Some businesses apply a small tolerance (e.g. 10%) before triggering a hold; others are strict. Whichever you choose, apply it consistently to avoid accusations of discriminatory treatment.
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