Table of contents5 sections
Trade credit limit: how to set a safe exposure to a customer
A client orders goods regularly, the relationship is going well, and the salesperson wants to increase sales. A natural decision comes up: let us extend the payment term, or let the customer order more before settling earlier invoices.
The problem starts when the value of subsequent deliveries grows faster than payments.
On the client’s account there are invoices not yet due, the first overdue documents, goods already released from the warehouse, and further orders waiting to be fulfilled. Each item on its own may look safe, but their combined value means the company is financing the counterparty with a far larger amount than it originally assumed.
We know what it is like when the decision to continue working together rests on trust, a good relationship and a belief that the client “always pays in the end”. Such a model works until one larger receivable fails to arrive on time, while the company still has to pay its suppliers, employees and public authorities.
That is why a trade credit limit should be a specific, monitored value, not a verbal agreement between the owner, the salesperson and the client.
A client orders goods regularly, the relationship is going well, and the salesperson wants to increase sales. A natural decision comes up: let us extend the payment term, or let the customer order more before settling earlier invoices.
Why the lack of a trade credit limit threatens liquidity
By granting trade credit, a company hands over goods or performs a service to the client before receiving full payment. In practice, it finances the customer’s business from its own funds.
If the exposure is not controlled, rising sales can increase the risk of losing liquidity instead of improving the company’s position.
Payment gridlock arises when business owners do not receive money from their counterparties on time. Non-payment can pass the problem on to the next companies in the supply chain, because the creditor itself starts to struggle to pay its own obligations.
The company controls overdue invoices but ignores the total exposure
The most common mistake is to analyse only documents that are past due.
Meanwhile, the risk towards a client also includes:
- invoices whose due date has not yet passed,
- goods released but not yet invoiced,
- orders being picked,
- accepted orders awaiting dispatch,
- costs incurred to fulfil the next order,
- additional services performed before an invoice is issued.
A client may have no overdue invoices and at the same time be using almost all of the capital the company is prepared to commit to financing them.
The limit is raised under sales pressure
The salesperson sees a chance to fulfil another order. The client assures them that the transfer is already prepared or that the previous invoice will be paid in the next few days.
In such a situation it is easy to agree to an exception.
A one-off departure from the rules can quickly become the new standard, however. If the organisation has no clear rules, every subsequent decision depends on:
- the value of the order,
- the strength of the relationship with the client,
- pressure to meet the sales plan,
- the owner’s availability,
- the judgement of a particular salesperson,
- declarations made by the customer.
As a result, two clients with a similar risk may receive completely different terms.
The company ignores actual payment behaviour
The formal payment term does not always match reality.
A client may have 30 days on the invoice but regularly pay after 42 days. If the limit was set on the assumption of on-time payment, the actual financing period is much longer.
Particularly important are:
- the average number of days of delay,
- the longest delay to date,
- behaviour on higher-value invoices,
- the number of partial payments,
- the payment trend,
- the frequency of requests to change the term.
A client who pays is not always a safe client. What also matters is when they pay and how large an exposure remains on the seller’s side in the meantime.
One client uses too large a share of the available cash
Even a reliable customer can pose a risk if they account for a large share of the company’s open receivables.
If a large part of working capital is tied up in serving one entity, any delay can affect the ability to:
- pay for further deliveries,
- maintain stock,
- pay salaries,
- pay taxes on time,
- accept new orders,
- serve other clients.
A limit should therefore take into account not only the quality of a given counterparty, but also its share of the entire receivables portfolio.
How to set a trade credit limit for a client
There is no single universal amount that is right for every customer. A limit should result from a combination of sales value, payment history, the length of the term and the seller’s financial capacity.
1. Calculate the full exposure to the counterparty
Before setting a limit you need to define what will count towards it.
The safest approach includes:
- overdue invoices,
- invoices not yet due,
- uninvoiced deliveries,
- orders approved for fulfilment,
- expenses incurred specifically for a given client.
You can adopt a simple formula:
Limit utilisation = open receivables + uninvoiced deliveries + approved orders
If a client has a limit of 100,000 PLN, open invoices of 60,000 PLN and an approved order of 35,000 PLN, they are already using 95% of the available exposure.
2. Set a base limit according to the scale of the relationship
The starting point can be average monthly sales and the length of the payment term granted.
For example:
- average monthly sales: 80,000 PLN,
- payment term: 30 days,
- initial base limit: about 80,000 PLN.
With a 60-day term, the exposure can in practice cover two monthly sales cycles. This does not mean, however, that the limit should automatically rise to 160,000 PLN.
You still need to check whether the company has enough capital to finance the customer for that long.
The base limit should then be adjusted for:
- counterparty risk,
- payment history,
- the margin on sales,
- seasonality,
- concentration of receivables,
- security,
- the company’s own cash position.
3. Apply an adjustment for payment history
A practical solution is to assign the client to one of the risk groups.
Low risk
- long, stable relationship,
- payments on time,
- small deviations,
- good communication,
- no growing debt.
Such a client can receive a standard or increased limit.
Moderate risk
- regular delays of a few days,
- occasional requests to postpone the term,
- longer delays on high-value invoices,
- a growing value of open receivables.
The limit should be more conservative, and its utilisation monitored more often.
High risk
- lengthening delays,
- several overdue invoices,
- partial repayments without a specific schedule,
- no response to payment reminders,
- a sudden rise in orders.
In such a situation an advance payment, prepayment or suspending further deliveries may be safer.
4. Define warning thresholds and rules for exceptions
A limit alone is not enough. You need rules that define what happens as it is used up.
An example model:
- up to 70% of the limit – orders fulfilled as standard,
- 70–90% – a warning and checks on planned payments,
- 90–100% – approval required from the person responsible,
- above 100% – the next delivery is blocked or a prepayment is mandatory.
The company should also specify:
- who can increase the limit,
- for how long an exception applies,
- what data is required before a decision,
- when the limit is reviewed again,
- what triggers its automatic reduction.
An exception without an end date quickly becomes a permanent, uncontrolled condition of the relationship.
How we solved limit setting in Administy
When we ran agencies, we did not at first call our exposure trade credit. The mechanism, however, was exactly the same.
We started work before receiving full payment. The team carried out tasks, we incurred the costs of specialists and subcontractors, and the client received an invoice with a deferred term.
The scope of work done before payment often resulted from individual arrangements and trust.
If a client had worked with us for a long time, it was easier to accept:
- an additional stage before issuing the invoice,
- starting further work before the previous work was paid for,
- an extended term,
- additional work without an advance,
- a greater commitment from the team.
The problem was that a good relationship did not always match the real level of financial risk.
That is why in Administy we introduced a data-driven approach.
We analyse, among other things:
- the value of open receivables,
- the number of documents outstanding,
- the counterparty’s average delay,
- earlier payment history,
- behaviour on invoices of different values,
- the payment trend,
- amounts already invoiced,
- funds actually paid in,
- the forecast date of the next inflow.
On this basis you can assess not only whether the client pays in the end, but also how large an exposure the company can safely maintain.
For example, a client may have:
- 50,000 PLN of invoices not yet due,
- 20,000 PLN of overdue invoices,
- 30,000 PLN of the next scope in progress.
The total exposure is then 100,000 PLN, even though a report of overdue receivables alone shows only 20,000 PLN.
In Administy we want to see the whole picture.
Payment history also helps determine whether the formal invoice term is realistic. If a client regularly pays 10 days later, the cash flow forecast should take that extra financing period into account.
As a result, the decision on the next stage of the relationship can be based on these questions:
- how much is already committed,
- when the money will probably arrive,
- how much it costs to continue the work,
- whether the next commitment will exceed a safe level,
- whether the company has the funds to finance this client.
Such an approach lets us replace the decision:
“We know the client, so we can do one more stage”
with the decision:
“The client is using 88% of the agreed exposure and their delays are growing, so we will start the next stage after receiving a partial payment.”
This does not mean automatically restricting sales. It means selling with full awareness of the cost and the risk.
A limit should grow together with trust confirmed by data
A good relationship with a client is important, but it should not be the only basis for financing further orders.
A trade credit limit should take into account the total exposure, the history of delays, the payment trend and the seller’s cash capacity.
Payment terms in commercial transactions are also subject to the applicable regulations. In transactions between private businesses of equal standing, the payment term should as a rule not exceed 60 days, with the exceptions provided for by law.
Check how much you are really financing your clients
Administy helps bring together open receivables, payment history, the delay trend and forecast inflows in one place.
Book an Administy demo and see how to set and monitor trade limits based on data, before a single counterparty uses too large a share of your company’s cash.
