Any B2B Ecommerce business has to strike a fine balance between sustaining cash flow and managing risk. On the one hand, even new customers may take the availability of credit lines for granted. On the other, there’s the stark statistic that 82% of businesses that fail do so because of cash flow problems. To ensure that flexible payment terms do not deteriorate into late payment or even bad debt, Ecommerce businesses can leverage credit limits. Used prudently, spending limits help to build strong customer relationships while mitigating risk.
What Are Credit Spending Limits?
If a business was only willing to accept upfront payments from buyers, the pool of potential customers would become significantly smaller. In fact, few B2B businesses would survive without the ability to offer flexible payments on net terms. With that comes the responsibility to establish the maximum amount of credit offered to a customer. There has to be a framework in place, and most businesses will set spending limits on a per customer basis according to:
- The buyer’s credit history as defined by external rating agencies – particularly for new business
- A current customer’s purchase and payment history
- Reporting from a company’s financial statements
- Trade references and testimonials
- Collateral and guarantees offered by a buyer as part of securities management
Based on the combined data from some or all of the above, a B2B business credit manager might agree to extend credit to a customer up to a limit of $5,000, for example. Rather than exceeding this limit to make further purchases, the customer would have to pay down some of their existing balance first.
Why Ecommerce Stores Set Credit Limits
As long as a store and buyer can agree on a mutually beneficial credit limit, the former can stay in control of their risk exposure and the latter can keep spending at manageable levels. Without spending limits, many B2B businesses would overextend, either because of cash flow issues or inaccurate forecasting. Given that 57% of B2B payments were collected late by small- to medium businesses in 2020, the specter of bad debt looms large.
Used effectively, credit limits encourage faster payment and limit the potential loss from customers who cannot pay. Not only does chasing late payment sap resources, but bad debt can have catastrophic consequences on the bottom line for a business that is borrowing close to its limit itself. In many sectors, such as financial services, credit risk management is a mandatory part of Know Your Customer (KYC) compliance, but any B2B business should see it as basic due diligence before onboarding new buyers.
Some businesses will even choose to outsource to a third-party partner who will assume responsibility (for a fee) of validating clients, setting credit limits, processing invoices and collecting payments, as well as assuming the risk for non-payment. While that might offload some of the processes, the cost can be similar to that of a credit card payment, which may exceed what some B2B businesses can afford to give up within their profit margin.
Agreeing to acceptable credit limits with customers is not just a matter of mitigating risk. Consumer lending through credit limits can also increase average order value (AOV) and revenue, particularly among repeat customers who have recurring orders. The key principle is that the payment flexibility for the customer should not come at the expense (literally) of the vendor.
Setting Ecommerce Store Credit Limits
It’s important to base decisions on cold data rather than emotion and to have a consistent policy instead of making ad hoc judgments. Common business formulas for establishing risk include:
Net worth calculation, which explores the buyer’s assets minus liabilities. A conservative spending limit would be 10 times this figure, so if a potential buyer had a net worth calculation of $10,000, their credit limit would be $100,000.
Daily Sales Outstanding (DSO) is calculated by dividing average accounts receivable by the total value of sales multiplied by the number of days in the month, this figure gives an accurate snapshot of buyer cash flow. Typically, a healthy DSO should be below 45.
Zoey Credit Limit Feature
As part of our Net Terms tool available for each customer, Zoey’s Credit Limit feature allows your B2B business to stop orders from being placed until existing orders are paid down. Limits can be set by user, location or account according to the net terms period for each customer. It’s a simple way to establish acceptable risk and it’s easy to set up:
- Enable Net Terms for the account in the customer settings tab
- Configure the terms for the customer (eg. net 30) and credit limit
- View the current terms for each customer in the dashboard and see the status of all existing orders and accounts.
Rather than a “set and forget” feature, the credit limit should be monitored and updated regularly, considering that seasonality and economic context can affect cash flow. From a customer perspective, the imposition of a spending limit is not necessarily a gesture of distrust. It provides transparency and can even be offered as a reward for regular timely payments.
We’re Here To Support You
If you’re looking to stay on top of the terms you offer each customer, add Zoey’s Credit Limit feature to your payment processing. It’s the easy way to reward your most valuable customers with more flexible terms, and secure your own financial position for any customer who presents a potential risk. With Zoey, you can go beyond simply managing credit limits and start utilizing their full value. To learn more, talk with us today:
Nick Marshall is a freelance writer from the UK covering B2B marketing, emerging tech, payments and Ecommerce. He lives on a tiny island with slow internet in the French Caribbean, but was formerly an agency copywriter in the UK.
