Credit limits and credit days: how to decide who gets credit and how much

What are credit days and a credit limit?

Credit days are how long a customer may take to pay an invoice; a credit limit is the most they may owe you at any one time. The first controls when money comes in. The second controls how much of your cash sits with one customer.

• Credit days (also called payment terms): 30 days means an invoice dated 1 October is due on 31 October.
• Credit limit: a cap on the customer's total outstanding balance, across all unpaid invoices, not on one invoice.
• Outstanding (or receivable): what the customer owes you right now, after payments and credit notes.

You need both. A customer on 30 days with no limit can run up three months of orders before the first one is even overdue. A customer with a limit but no agreed days has no date to be chased against.

How many credit days should you give a customer?

Give the shortest credit period your market accepts, and never more than your cash cycle can fund. Three inputs decide it.

1. 1

   Start from the industry norm

   Ask what your competitors and your customers' other suppliers offer. If the trade runs on 30 days, offering 15 loses orders and offering 60 gives money away.

2. 2

   Check your own supplier terms

   If your suppliers give you 30 days and you give customers 60, you are lending your customers money for 30 days out of your own pocket.

3. 3

   Work out your cash cycle

   Cash cycle = days stock sits + customer credit days − supplier credit days. That is the number of days you must fund from your own cash or a bank limit.

For Lakshmi Steel Furnitures, the fictional Coimbatore steel furniture maker on this site, stock sits about 20 days and Tamil Nadu Steels gives it 30 days. At 30 days of customer credit the cycle is 20 + 30 − 30 = 20 days. At 45 days it becomes 35 days. With ₹6,50,000 of monthly credit sales, those extra 15 days tie up about ₹3,25,000 more of working capital.

Write the credit days on the quotation, the order and the invoice. A term the customer never saw in writing is a term they will not keep.

How do you set a credit limit for customers?

Set the credit limit at roughly the value a customer buys during one credit period, so a customer who pays on time never hits it. Two formulas cover most cases.

• Use expected purchases for the next quarter, not last year's peak month.
• Add headroom of up to a quarter only for customers with a clean payment record of a year or more.
• Cut the result for anyone who regularly pays well after the due date.
• Round to a figure you can say on the phone without a calculator.

What does a credit policy look like for five real customers?

Here is how Lakshmi Steel Furnitures sets terms for five customers, together buying ₹6,50,000 a month on credit.

Look at the total. Lakshmi Steel has agreed to carry up to ₹8,05,000 of customer credit. If its bank limit and spare cash cannot cover that, the limits are too generous, however good each customer looks on its own.

What should happen when an invoice crosses the limit?

When a new invoice would push a customer over the limit, someone with authority should decide before it goes out, not after. The usual choices are to ask for a payment first, ship part of the order, or approve the excess once.

Suppose Ravi Stores owes ₹1,32,000 and orders goods worth ₹23,600. Outstanding plus the new invoice is ₹1,55,600, which is ₹5,600 over the ₹1,50,000 limit. A sensible rule: ask Ravi Stores to clear its oldest invoice, then release the order.

In SimpleERP, the invoice screen shows a warning when the customer's receivable plus this invoice exceeds their credit limit. The warning does not stop the invoice. Posting it still needs the Approve permission, so a user without it can prepare the invoice while someone who holds it decides whether it posts.

When should you raise or cut a customer's credit limit?

Raise a limit when the customer pays on time and keeps hitting it; cut it as soon as their payments slip. The signals are in your receivables, not in what the customer tells you.

The debtors ageing report shows these signals at a glance: who is past due, by how much and for how long.

What credit rules should a new customer get?

A new customer should earn credit by paying for a few orders first. Many small businesses use a simple rule: advance or cash for the first three orders, then a small limit.

• Collect the GSTIN, billing address and a named person for payments
• Take advance or cash on delivery for the first three orders
• After the third order, set a limit of about half a month of their purchases
• Put the credit days in writing on the first credit invoice
• Ask for one trade reference if the first credit order is large
• Review the limit after three months of on-time payment

How often should you review credit limits and credit days?

Review every customer's credit terms once a quarter, and any customer the moment an invoice goes more than 30 days past due. A quarterly review takes under an hour for most small businesses.

1. 1

   Open the receivables ageing

   Note each customer's outstanding and how much is past due.

2. 2

   Compare outstanding with the limit

   Customers always near the limit and paying on time are candidates for a raise. Customers over it need a call.

3. 3

   Check how long each customer actually takes to pay

   If actual days are well beyond agreed days, either cut the terms or ask for advance.

4. 4

   Recalculate limits from expected purchases

   Use the two formulas above with the next quarter's expected sales.

5. 5

   Tell customers what changed

   Send a short note with the new terms and a statement of account.

How does SimpleERP help you manage customer credit?

SimpleERP keeps payment terms, credit days and a credit limit on every customer, warns on the invoice when the limit would be crossed, and needs the Approve permission to post. Receivables and ageing update from posted invoices and payments, so the numbers you review are the numbers in the books.

• Receivables ageing by party with bucket columns, and a row that expands to the open invoices.
• One payment can be allocated across many invoices, and an advance sits on the customer until it is applied.
• A statement of account per customer with opening balance, running balance and an ageing footer, to print, save as PDF or copy as share text.
• Reminder text to copy and send from your own phone or email.

Read more on the payments and receivables page, or start with the full accounts receivable guide. If you supply as a micro or small enterprise, also read the MSME 45-day payment rule.