How to develop credit terms and limits that walk the fine line between stimulating growth in your customers, maximizing cash flow, and minimizing risk.
Determining credit limits is a difficult task. Even if two businesses are related in terms of industry, size, or location, they may require different approaches when it comes to extending credit.
For SMB’s, the challenge is even steeper. Over 60% report difficulties managing their cash flow effectively, making it risky to offer credit without a strong data foundation to inform your decision. Getting your limits wrong—whether too restrictive or too lenient—can lead to lost sales, defaults, or long-term bad debt.
Enterprise-level organizations typically rely on decades of data and detailed credit policies to guide their decisions. But as an SMB, you might not have that luxury.
Even if you have clear credit policies, without extensive, easily accessible historical performance data refined from tracking customer behavior, you can find yourself walking your own kind of Credit Tightrope, balancing growth and risk on every limit with far less room for error.
So, how can you confidently set and adjust credit limits without falling off?
To make it to the other side of the tightrope without these data-backed guardrails, you must find the right balance of risk mitigation techniques and solid data to hold tight to.
Before extending credit to a new customer, it’s essential to first assess their creditworthiness. This includes reviewing their current financial condition, past payment behavior, and any obstructions in their ability to pay. To make a well-informed decision, you may request either all or some of the following:
This is the crux of the tightrope problem: Without being informed by extensive past performance data, how do you take what you have learned about a customer from these sources and use it to assign credit limits that will A) not expose your business to significant risks and B) satisfy your customer?
There are many ways to approach this problem, but they can be segmented into two basic categories, Foundational and Advanced.
As an SMB credit manager, your credit evaluation and limit-setting process may follow a more foundational approach, one that relies on core credit practices and hands-on analysis.
This often includes reviewing the information provided to you in the credit application, checking bank and trade references, and pulling reports from business credit bureaus. From there, how you calculate a credit limit depends heavily on your internal credit policy. In many cases, it is done by extending all—or a percentage—of a credit bureau’s recommended limit.
In this model, the requesting, collection, assessment, and verification of information are done through primarily manual means. This might involve entering applicant data into spreadsheets, requesting references by hand, and working with a mixture of digital and paper-based documents that form the credit profile of your applicant.
While it gets the job done, as your application volume grows and your customers become more complex, scaling and maintaining consistent practices with this method can become difficult.
Without purpose-built digital credit review automation software, adopting a more advanced approach is an uphill battle.
Although the data sources remain largely the same as in a foundational approach, two major differences set advanced analysis apart:
First, there is a significant improvement in the speed and breadth of data collection. Automated systems can request references at the moment of application submission, reducing processing time. They can also integrate directly with credit application portals, triggering immediate outreach to trade references, pulling real-time credit scores, and even flagging inconsistencies or risks—before any manual review begins. What might take hours—or days—in manual effort can be reduced to minutes.
Second, advanced credit management platforms improve your ability to assess applicant data. Finely tuned scoring models are utilized to assign credit limits based on the weighted value of each source. By assigning different weights to each data source, you can take a more structured, risk-adjusted approach to setting credit limits.
Regardless of the method you choose to base your credit limit calculations on, there are best practices available to reduce the risk of default and facilitate growth, especially during credit reviews.
Read on to learn more about how automated digital credit systems can empower credit managers to work with greater efficiency.
Just because your first step on the Credit Tightrope is a success doesn’t mean you are in the clear. An initial credit limit is only the beginning. Shifting circumstances, either within a customer's business or market or in global economic conditions, like a gust of wind, can send you over the edge.
By actively monitoring early warning signs and adjusting limits based on the most recent data available, you can reduce your risk exposure while fostering growth opportunities for customers who demonstrate reliable behavior.
When navigating the Credit Tightrope, setting credit limits at a standardized rate can do more harm than good. Each of your customers brings a different financial and behavioral profile to the table, understanding and adapting to those nuances is at the heart of effective credit management.
A tiered approach allows you to turn credit limits into more than just a risk control measure, they become a strategic lever for nurturing relationships and driving growth. Rewarding businesses that demonstrate good payment behavior and restricting those that do not provides your customers with an implicit incentive.
Example of a tiered approach:
A tiered approach can also position your business to better compete in your market. Customers will go where they are given the best terms, and if they are offered a clear path to expansion, they will more readily accept a lower initial limit.
Many businesses fall into the trap of focusing too heavily on assessing new applicants while overlooking the limits of their existing ones. Regular credit reviews are essential for maintaining the delicate balance of your credit operations.
Reviews at consistent, well-timed intervals provide you with early insight into any changes in a customer’s financial health. By examining financial data and payment behavior over time, it becomes easier to identify trends that may lead to disruptions and defaults in the future. With that foresight, you can act quickly, adjusting payment terms and credit limits to proactively manage risk and rebalance your approach.
Just as consequential as the interval of the credit review, the data you use to assess credit terms is critical to preventing disruptions to your cash flow. Personal relationships with customers, while critical to cultivate, can often blur even the most experienced credit managers' perception of risk.
Judgment alone cannot predict all outcomes. Constantly requesting and looking for the most recent data available, whether that be bank and trade references, cash flow statements, balance sheets, DSO, internal aging reports, collections notes, legal activities, and more, can provide both the qualitative and quantitative information needed to come to an informed decision.
Consistently initiating outreach with your customers can significantly enhance your ability to assess the impact of a credit limit. When touchpoints are frequent, you gain a greater understanding of not only how a particular business operates but also how they see the limitations and opportunities that their current limit affords them. This kind of proactive communication also strengthens your ability to collect, providing an opening for you to intervene early when payment issues arise.
As a credit manager, your perspective goes beyond just financial statements, payment behavior, and references; it includes a broader view of the market and industry conditions that influence your customers' ability to pay. A model, long-term customer who pays early and in full can just as quickly become a major source of risk with a large credit limit to lean on and utilize when their cash flow begins to decline.
If your reviews are not in tune with the trends of the industry you operate in, reviewing customers based on historical and current data can quickly leave you out of position and exposed to major market downswings.
On the other hand, sudden changes such as loosened regulations, new technologies, and increased market demand can cause your credit limits to restrict customers from taking on new opportunities and expanding their market position.
Assessing a customer’s behavior and reputation within your industry can be challenging when viewed through the lens of their curated references. You can gain a greater understanding of their challenges and position through their appearances in, and mentions across, news sources. As well as their activity (and the activity of their customers) on their social media channels.
Effectively calculating credit limits and performing meaningful reviews depends on having access to the most current and relevant data. This is where automation and digital processes can make a measurable difference. Digital credit management platforms place you at the center of a network of live data resources and expert risk forecasting. By automating repetitive data calculation and computational tasks and leveraging real-time insights, you can quickly assess creditworthiness, monitor risk factors, assess growth, and make instant credit limit adjustments.
Learn more about how Bectran can sharpen your credit department's strategic impact.