A credit limit is the most you are willing to be owed by one customer at any moment. Set it too high and a single failure can do real damage to your cash flow. Set it too low and you turn away good business, or push your sales team to work around the system. This guide gives you a repeatable way to set a first limit for a new customer, and to adjust it once you have real payment history.
Start with what you know about the customer
Before you pick a number, gather the basics: the customer’s legal name and registration details, how long they have been trading, financial statements if they will share them, a report from a credit bureau or credit reference agency, and trade references. If you have not built that process yet, our guide on how to evaluate customer creditworthiness before extending credit covers it step by step.
The limit comes after the assessment, not instead of it.
Three ways to calculate a limit
No single formula suits every business. Experienced credit teams usually run two or three methods and, for a new account, start with the lowest result.
1. Expected purchases and your payment terms
This is the most practical method because it ties the limit to what the customer actually needs. Ask the customer (or your sales team) how much they expect to buy each month, then work out how much will be outstanding at the peak.
On 30-day terms, a customer will often owe you for this month’s deliveries and last month’s at the same time, before the older invoices are paid. A common approach is:
Limit = monthly purchases × (payment terms in days + buffer) ÷ 30
The buffer covers normal slippage, such as a customer whose payment run falls a week after the due date. Fifteen days is a sensible starting buffer for many businesses.
2. The customer’s financial strength
If you have the customer’s balance sheet, you can cap your exposure at a percentage of their net worth (total assets minus total liabilities) or their working capital (current assets minus current liabilities). The percentage is a policy choice. A cautious business might use 10% of net worth, so that no single supplier balance becomes an outsized share of the customer’s resources.
This method stops you extending more credit than the customer’s balance sheet can plausibly support, even when their order forecast is ambitious.
3. A credit report’s recommended limit
Many credit reports include a suggested credit limit or a risk score. Treat it as a useful reference point, not a decision. The bureau does not know your margins, your terms or how much of the customer’s spending will come to you. If you will be one of many suppliers, you may decide to use only part of the recommended figure.
A worked example
Say a new customer, a regional distributor, wants to buy about $20,000 (or £20,000) of stock a month on 30-day terms.
- Purchases method: $20,000 × (30 + 15) ÷ 30 = $30,000
- Net worth method: their latest balance sheet shows net worth of $400,000. At 10%, that gives $40,000.
- Credit report: the report suggests a limit of $35,000.
The lowest figure is $30,000, which also matches the customer’s real need. For a brand-new account, you might start a step lower at $25,000 and commit to a review after three months.
Now change one number. If net worth were $150,000, the net worth method gives $15,000, half the customer’s expected need. You then have a choice: offer $15,000 and accept smaller or more frequent orders, ask for a deposit or guarantee to cover the gap, or decline. A decision like that should sit with someone senior, which is where approval levels come in.
Start conservative, then review
A new customer has no payment history with you. It is far easier to raise a limit for a customer who pays well than to cut one for a customer who has already over-ordered.
Set a formal review 3 to 6 months after opening the account. At the review, look at:
- Whether invoices were paid on time, and if not, how late on average
- Whether the customer stayed comfortably within the limit or kept hitting it
- Any disputes and how quickly they were resolved
- Any change in their credit report or financial statements
If they paid on time and need more room, raise the limit in steps rather than one big jump. If they paid late, hold the limit or reduce it, and talk to the customer about why. Regular limit reviews are one of the habits covered in our top 10 best practices for effective credit control.
Set approval levels
Not every limit needs the same sign-off. A tiered structure keeps small decisions fast and large ones properly reviewed. For example:
| Credit limit | Who approves |
|---|---|
| Up to 10,000 | Credit controller or AR specialist |
| 10,001 to 50,000 | Credit manager |
| 50,001 to 150,000 | Finance director or controller |
| Above 150,000 | CFO, or CFO plus managing director |
Adjust the bands to suit your size. What matters is that everyone knows who can say yes, and nobody approves above their own authority because a sale is waiting.
Document the decision
Every limit should have a short written record. It should answer the questions an auditor, a new colleague or your future self will ask:
- Date of the decision and who approved it
- Information used (credit report date, financial statements, references)
- Which methods you used and the figures each produced
- The limit and payment terms agreed
- Any conditions, such as a deposit, guarantee or review date
Keep it on the customer’s record in your accounting software or credit file, so the next limit review starts from facts.
When to require a deposit or guarantee
Sometimes the right answer is “yes, with security.” Consider a deposit, payment in advance or a guarantee when:
- The customer is newly formed or has little trading history
- Financial statements are unavailable, or show weak or negative net worth
- The credit report shows late payment to other suppliers, court judgments or other adverse records
- The requested limit is well above what your calculations support
- The first order is unusually large, or involves custom goods you cannot resell
Common options include a deposit on each order, cash in advance for the first few orders, a personal guarantee from a director or owner, a parent company guarantee, or a standby letter of credit. Requirements for these differ between the UK, US and Canada, particularly for personal guarantees, so have your wording checked by a qualified adviser in your jurisdiction before you rely on it.
Make conditions temporary where you can. “Cash in advance for the first three orders, then 30-day terms up to $15,000” gives a good customer a clear path to normal credit.
Key takeaways
- Calculate a limit two or three ways and start a new account at the lowest figure.
- Base the main calculation on expected monthly purchases and your payment terms, plus a buffer.
- Review new accounts after 3 to 6 months and raise limits in steps for customers who pay well.
- Use clear approval levels and record every decision, including the information behind it.
- Ask for a deposit or guarantee when the numbers or the history do not support the limit requested.
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