There are credit management standards for vetted and authorized new account credit limits.
One If expected monthly turnover is £1000.00 per month, with 30 days allowed for payment, a credit limit of £2000.00 (being 2 x monthly sales) is normal. This will allow for a degree of growth.
Two By analyzing published accounts or purchasing a credit reference report you can allow, say, 10% of net worth or 20% of working capital. The lower figure of the two would be the credit limit.
Three Finally, whatever credit limit you are willing to offer.
If a customer wants a higher credit limit, and an extended payment period, to those offered, you should not automatically say "no". You should find out where your supply/service fits in to the customers overall operation. You may be able to be creative with your terms & conditions, to the benefit of both parties. However, if your cash flow demands full payment within 30 days, be firm.
When you consider a request to raise a credit limit, it is advisable to take this opportunity to reassess your customer. There are many reasons why a customer would want an increased credit limit: not all of them are good reasons. Many companies raise credit limits because the customer has exceeded the current limit! You must be in control of your cash flow, not your customer.
You must avoid the 'do or die' companies that search for credit to support a weak product, service, company or management. If a company approaches you with the 'greatest idea since sliced bread', but need your financial support (credit terms) show caution, unless you are into ‘venture capital’!
You need to be on the lookout for professional debtors (known as 'Long Firms'). They look to establish a good credit relationship with you over a period of months: they are prompt payers and never complain. You then get a request for a very large order: with lots of profit for the both of you. You deliver the goods to the customer: the customer sells the goods immediately for a low cash figure. You, of course, never see a penny of the cash, and the company has either ceased to trade, claims insolvency, or turns out to have never existed in the first instance.
Assessing and rating your customers takes experience (but hopefully not too many hard lessons). However, following a set policy will reduce your risk and increase your profit. The days of looking at someone and thinking ‘they look all right’ are long gone.
For those of you who already apply all or most of the systems and procedures explained in these notes, you will know that the risk of late payment or bad debt is reduced substantially in comparison to those who do not deploy good credit management.
Finally, a customer who is vetted and authorized by such a system is aware of your professional attitude to credit management. As such, a customer with cash flow problems will not, on average, take the risk of you taking firm action to secure your rightful dues. Would you risk owing money to a company that deploys professional credit management, (that's right, I would not either)?
Rating
It is usually sufficient to use three categories to rate your client/customer:
Risk Grade 'A' = Low Risk
Risk Grade 'B' = Average/Normal Risk
Risk Grade 'C' = High/Above Average Risk
A grade 'A' example could be a company trading for 10 years, always pays on time, and has no known adverse condition.
A grade 'B' could be a company trading for 3 years, pays form 0 - 14 days late, and has no known adverse condition.
A grade 'C' example could be a new, young, or troubled (within reason) company, pays usually 30 days late, and rumours are that they are a 'bit shaky', but you have supplied them for many years.
You can have 'B+', 'B-' etc. to expand your categories, or even words/phrases such as 'on stop' or 'review all sales'. You could review all 'C' grades every 30 days, 'B' every quarter and 'C' every 6 months.
Don't Ignore the Obvious
We all want as many sales as possible. When sales are on a cash only basis we would gladly sell to (almost) anyone. When that sale is on credit, you must step back and view this customer from top to bottom, and side to side. You must not add up the sales figure before assessing the risk.
If the main attraction to the customer is that you supply credit, watch out! If the customer has ten suitable suppliers nearer to home, watch out! If the customer talks of 'big money' deals, but the tatty van outside has no tax, watch out!
Think, 'why did they come to me!' If you do not think this before giving credit, you will surely think, 'why, oh why, did they come to me' after you have problems recovering your money.
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