Credit checking your customers and setting credit limits

Offering credit as a payment option can open your business up to new potential customers and increase your profits in the long term.

However, there are a number of factors you should consider before offering credit to customers. If customers default on their credit payments, it could leave your business short of finances and cause you problems. Ensuring that your customers can pay back the amount of credit you have allowed them should be a priority, and there are systems you can employ to help this happen.

This guide explains how to assess your potential customers’ credit ratings and also covers checking new – and current – customers and how you should set their limits.

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Credit checking potential customers

If you don’t know a potential customer’s credit history, there is a risk of being paid late or not being paid at all.

Therefore, you should ask all potential customers to complete a form authorising you to get bank, credit and trade references.

The form should include:

• The full name of the customer’s business and any other names it trades under.
• Details of who owns – and who runs – the business.
• The legal status of the business, eg sole trader, partnership, limited liability partnership, public limited company. For more on the various legal structures, see our guide on legal structures: the basics.
• Registration number – if it’s a limited company.
• How much credit is being asked for.
• Full contact details of the person responsible for payment queries.
• Delivery and invoice address if different.
• Bank account details.
• A request for consent to make bank reference checks.
• A request for consent to get a credit check from a credit reference agency.
• A request for consent to get at least two trade references – make sure that you, not your customer, choose which to approach in order to get an independent view.

You should then make the necessary checks with the customer’s bank, a credit reference agency and some of their suppliers.

You can also get information from:

• Companies House – for checking a limited company’s accounts
• Registry Trust Ltd – for searching the register of county court judgments
• The Insolvency Service – a registry of individual voluntary arrangements and bankruptcies
• Institute of Credit Management/Credit Management Research Centre – league tables of payment times for all public limited companies in the UK
• local newspapers
• the internet – online searches of individuals and businesses

If you are still unsure about the creditworthiness of a customer, you could consider having a third-party guarantee. This is a legally binding agreement with a third party that they will pay if the customer does not.

The Accountant in Bankruptcy (AiB) is responsible for bankruptcies in Scotland – find guidance on bankruptcies on the AiB website- Opens in a new window.

Scottish businesses can find information about corporate liquidation on the Companies House website- Opens in a new window.

Businesses in Northern Ireland can read about insolvency on the Department of Enterprise, Trade and Investment website- Opens in a new window.

You also need to make sure your terms and conditions are correct for any credit you set up. For more information, see the page on setting terms and conditions in our guide on invoicing and payment terms.

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Credit checking new customers

In some circumstances, you might allow new customers credit without making the necessary checks in advance.

For new accounts making small orders, you could offer a ‘fast-start limit’ of around £500.

You could then apply the 80/20 rule to identify the largest accounts that make up 80 per cent of sales. Download guidance on the 80/20 rule from the Chartered Institute of Marketing website (PDF, 121K)- Opens in a new window.

Once you have identified your most important customers, credit check them as necessary.

Ideally, all customers should be credit checked so that the amount outstanding from them is controlled and future sales efforts can be focused on your most reliable customers – there is no point wasting time on customers who represent a greater financial risk.

For more information, see the page in this guide on credit checking potential customers.

Ongoing monitoring

You should try to monitor accounts for trends, eg slowing payments, detailed queries regarding deliveries which consistently lead to delays in payment.

If you think that you have a problem with a customer, make checks as necessary, by:

• using credit insurers
• getting sales or credit staff to visit the customer
• getting additional trade references

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Setting levels of credit

It may be difficult to determine the amount of credit to give – particularly with a potential or new customer.

You can therefore get a:

• credit check from a credit reference agency – see the pages in this guide on credit checking potential customers and credit checking new customers
• decision from a credit insurer

Alternatively, you could make the decision yourself and set a credit limit for each customer. You should set a customer’s limit according to how good their credit rating is. If their credit rating is good, you could set the limit at double their monthly sales figure. The limit should be reduced for those customers with poorer credit ratings.

The limit will need reviewing as potential sales levels change.

Make sure your staff are aware of each customer’s credit limit.

You could also devise a simple system of risk codes to apply to each account, for example:

• A (low risk) – customers with the best credit references and payment records
• B (average)
• C (high risk) – those who your credit checks reveal have had, for example, county court judgments made against them and are therefore most likely to be slow payers
• N (new) – customers you have traded with for less than six months

Once you have identified your ‘C’ customers, it might be better to concentrate sales efforts on the ‘A’s and ‘B’s.

However, if you can’t get enough business from ‘A’s and ‘B’s you might still have to take on some ‘C’ accounts – there may be good profit to be had from ‘C’s if you monitor them carefully and minimise your risks.

Don’t forget to review the system from time to time.

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