A new customer orders for €60,000 and asks for a 60-day payment term. Do you say yes? And what if they order another €60,000 next month while the first invoice is still outstanding? A credit limit answers that question in advance, with figures instead of gut feeling. Here you read how to set it yourself, how to turn it into an acceptance policy and how the indicative value on Jaarrekening.be is calculated.
Why you need a credit limit per customer
Every invoice with a payment term is an interest-free loan to your customer. If that customer goes bankrupt, ordinary suppliers get little to nothing back in most Belgian bankruptcies. So the question is not whether you give credit (in B2B you almost always do), but how much you are willing to lose at most if things go wrong. That amount is your credit limit: the ceiling on all outstanding invoices on one customer, due and not yet due together. Without a limit, what every accountant knows happens: a customer orders more and more, pays later and later, and on the day of the bankruptcy six months of turnover is outstanding.
If you first want to run the full check of a customer, from legal status to directors, read checking the creditworthiness of a customer. The limit below is the final step of that check.
Rules of thumb: equity and turnover
Credit insurers use models with dozens of variables, but for an SME two figures from the customer's annual accounts are enough to set a first range.
10 percent of equity
Equity is the buffer the customer itself has in the business. A limit of about 10 percent of that means your claim never eats up more than a tenth of that buffer. With negative equity this rule gives zero: then you supply only against payment in advance.
5 to 10 percent of annual turnover
This rule looks at the size of the activity: a company with €2 million turnover may buy €1.2 million a year from suppliers, so €100,000 to €200,000 outstanding with one supplier is large but not abnormal. Note: small companies filing the abbreviated format do not publish turnover, only gross margin. How to estimate it anyway is explained in finding the turnover of a company. The two rules rarely give the same number: they form a range, and the ratios determine where you sit within that range.
Worked example: a customer with €400,000 equity
Suppose your prospect has, according to the latest annual accounts, €400,000 equity, €2,000,000 turnover and a current ratio of 1.3. The rules of thumb give:
| Rule | Calculation | Limit |
|---|---|---|
| 10 % of equity | 400,000 x 10 % | €40,000 |
| 5 % of turnover | 2,000,000 x 5 % | €100,000 |
| 10 % of turnover | 2,000,000 x 10 % | €200,000 |
Which number do you choose? The current ratio of 1.3 says the customer has €1.30 of current assets per euro of short-term debt: above the minimum of 1, but not comfortably. Turnover is moreover five times equity, a thin buffer for that activity. So you sit at the bottom of the range: €40,000 to €60,000 as a starting limit, with a deposit if a first order goes above that. If the customer pays within the term for six months, you move towards €100,000. The €200,000 you keep for customers with a current ratio above 1.5, solvency above 30 percent and a spotless payment history.
Check liquidity, solvency and payment behaviour
The rules of thumb say how big the customer is; the ratios say whether they can actually pay you. Three checks, all to be found on the Key financials tab of a company:
- Current ratio (current assets divided by short-term debt): below 1 the customer does not have enough on paper to pay its short-term debts, so not your invoice either. Between 1.2 and 2 is healthy. See calculating liquidity and the current ratio.
- Solvency (equity divided by total assets): below 15 percent the customer is mainly financed with other people's money, and you stand at the back of the queue. More in calculating solvency, or calculate a limit straight away with the credit limit tool.
- DSO or customer credit in days: how long the customer itself waits for its money. A DSO of 90 days at a customer who has to pay you in 30 days is a structural cash problem that sooner or later lands with you. See the DSO check.
Add your own data to that: the customer's payment behaviour with you, the size of the contract and your margin. A customer with a 40 percent margin may get more credit than a customer with 5 percent, because in case of non-payment you lose mainly profit with the first and mainly costs with the second.
How Jaarrekening.be calculates the credit limit
On the Overview and the Key financials tab of every company, Jaarrekening.be shows a suggestion under the name Credit limit. No black box: the calculation works in three steps, based on the most recently filed annual accounts.
- Three base components. Turnover (or, with an abbreviated format, a derivative of gross margin), equity and EBITDA. Each gets a weight: turnover weighs most, then equity and EBITDA. Together they give a rough amount that reflects the size of the company.
- Health factor. That amount is scaled with a factor from three ratios: solvency (reference 40 percent), liquidity (current ratio, reference 1.5) and net profitability (reference 15 percent). Each ratio is capped, so that one exceptionally strong ratio cannot inflate the limit when the other two are weak.
- EBITDA margin. A positive margin adds up to about 30 percent, a negative margin takes up to 15 percent off. The result is capped at €10 million and is never negative.
The result is an indicative value for the total open position you could accept on that customer. It rests solely on the annual accounts, which may already be 7 to 19 months old when you read them, and knows nothing about your contract, your margin or the customer's payment behaviour with you. Use it the way a credit insurer uses its first estimate: as a starting point you adjust with your own information, not as a guarantee.
Credit limits in your acceptance policy
A limit only works if everyone in your company applies it, including the salesperson who has just landed a nice order. So pour it into a simple acceptance policy with three colours, which you adapt to your own sector and margins:
| Category | Criteria | Credit limit and conditions |
|---|---|---|
| Green | Solvency above 30 %, current ratio above 1.5, profit in the last two financial years, annual accounts filed on time, normal legal status | Full limit (top of the range), 30-day payment term, review at the new annual accounts |
| Orange | Solvency between 15 and 30 %, current ratio between 1 and 1.5, fluctuating results, DSO above 60 days, or a new customer without history | Half limit (bottom of the range), deposit of 30 to 50 % above the limit, shorter payment term, review every six months |
| Red | Negative equity, current ratio below 1, two years of losses, annual accounts late or not filed, judicial reorganisation or another abnormal legal status | No credit: payment in advance or on delivery, possibly a bank guarantee or retention of title in the contract |
Lay down who may approve an exception and put the limit in your ERP or invoicing software, so that a new order is automatically blocked as soon as the outstanding balance exceeds the ceiling. For large contracts a risk analysis per customer can substantiate the decision towards your bank or credit insurer.
Review the limit and let alerts do the work
A credit limit is a snapshot: the annual accounts it rests on get older, and the customer changes. So build in a fixed rhythm:
- Annually, when the new annual accounts are filed (for most companies between July and September): recalculate the range and move the customer to the right colour.
- Every six months for orange customers: look at the payment behaviour of the past six months and adjust the limit.
- Immediately at a signal: a payment more than 30 days late, a director resigning, a registered office move, a changed legal status or annual accounts that do not arrive on time.
The last one cannot be kept up manually for dozens of customers. With monitoring and alerts you follow your customers and receive an e-mail on the day a new set of annual accounts, a change of director or a change of status appears. The limit you set in January then does not sit unnoticed until the reminder comes back.
In summary
Set a ceiling per customer for the total of outstanding invoices. Start with 10 percent of equity or 5 to 10 percent of turnover, choose within that range on the basis of current ratio, solvency and DSO, and correct with your own payment experience and margin. The indicative value on Jaarrekening.be gives that starting point at a glance. Put the whole into a green/orange/red policy, review it at every new set of annual accounts and let alerts do the rest. That way you give credit to those who deserve it, not to those who ask loudest.