How to Set Trade Credit Limits & Payment Terms: A Step‑By‑Step Guide for Businesses

Offering trade credit – allowing business customers to buy now and pay later – can boost sales and help customers grow. But it also exposes you to risk: late or missed payments can disrupt your cash flow.. To balance sales growth with safety, you need a clear process for assessing a customer’s creditworthiness, setting an appropriate credit limit, and agreeing on payment terms. In this guide, we’ll walk through the key factors and methods – applicable across industries – that businesses use to determine how much credit to extend and under what terms.

Assessing Customer Creditworthiness

Before granting credit, evaluate how likely the customer is to pay on time. In general, creditworthiness depends on financial health and payment history. Here are the main factors to consider (It should be noted that this represents an ideal scenario, in many cases you may not have access to all this information.)

Financial statements and cash flow: Look at the customer’s revenue, profits, and cash flow. Strong, growing revenue and healthy margins suggest capacity to pay. Also check their balance sheet: do they have enough current assets (cash, receivables) relative to current liabilities? In short, you want to know if existing debts and cash outlays will leave room to pay your invoice on time. For example, review their debt levels and cash flow ratios or request recent financial statements.
Payment and credit history: Examine how the customer has paid other suppliers. Ask for trade references or run a business credit report from agencies like Dun & Bradstreet or Experian. These reports show invoice payment histories, outstanding accounts, and any judgments or collections. A good track record of on-time payment (or a high business credit score) is a strong positive. Conversely, any history of late payments, bankruptcies or liens signals risk.
Industry and economic conditions: Consider the customer’s industry norms and current market trends. Some industries routinely pay more slowly (e.g. construction or government contractors often use net-60 or milestone payments). Others pay quickly or even require payment on delivery. Also watch for any sector downturn or seasonality that could hurt cash flow. For example, if commodity prices or supply chain issues squeeze your customer’s margins, they might struggle to pay.
5 Cs of credit: A helpful framework is the “five Cs” of credit: Character, Capacity, Collateral, Capital, and Conditions. In practice, this means checking the customer’s reputation and trustworthiness (character), their cash-flow and debt ratios (capacity), any assets they could pledge (collateral), their overall financial strength (capital), and external factors like economic conditions (conditions). While you may not perform a full credit-scoring model, keeping these ideas in mind will guide a well-rounded assessment.
Order size and relationship: Larger orders naturally increase your exposure. If a customer wants a big credit line, consider whether they have earned it. For new or one-time buyers with no record, start conservatively. If it’s a long-term customer, factor in the history you have with them. Also ask sales or account managers for insights: is this customer key to your business? Have they been reliable partners? Internal feedback helps gauge qualitative factors that reports may miss.

By combining these elements – financial data, reports, references, and context – you’ll form a clear picture of each customer’s credit risk. Remember that no single number or score gives the full answer; rather, it’s about painting a full picture before setting limits.

Setting the Credit Limit

Once you’ve assessed creditworthiness, the next step is to choose a credit limit (the maximum unpaid balance allowed). There’s no one-size-fits-all formula, but common practices include:

Using financial formulas or ratios: Some companies set limits based on the customer’s balance-sheet figures. For example, one method divides a customer’s net working capital or net worth by the number of creditors, to estimate a safe exposure per supplier. NACM (National Assoc. of Credit Management) suggests using calculations from financial data (like net worth or current assets) to derive an initial limit.
Benchmarking to industry standards: Look at what other suppliers are offering similar terms. If your customer is already buying from competitors, you might try to keep your limit in the same ballpark. Industry trade groups or your own trade references can tell you typical credit lines and terms for businesses of that size.
Starting low and growing with performance: A prudent strategy for new or higher-risk accounts is to begin conservatively and raise the limit over time. You can grant enough credit for the customer to place a decent initial order, then use their payment behavior as a guide. If they consistently pay on time, it’s reasonable to gradually increase their limit. This builds trust on both sides: the customer knows they can earn more buying power, and you limit your worst-case exposure.
Setting internal policies: Your company should have a clear credit policy that defines how limits are set for different customer segments. For example, you might say, “For any customer with annual sales under $X or new customers, the default limit is $Y,” with manager approval needed for exceptions. A policy ensures consistency (customers in similar situations are treated similarly) and helps your sales team explain decisions.
Using third-party data and credit scores: Many firms rely on external credit scores or risk ratings. For instance, credit bureaus (D&B, Experian) provide business credit scores, and credit insurers or fintech services offer risk ratings. You could tie your limit to these ratings: e.g., A-rated firms get a higher limit, C-rated firms only a small limit or COD.
Collateral or guarantees: If you’re willing to take collateral (e.g. a lien on equipment or inventory) or a personal/parent company guarantee, you can extend more credit securely. For very large or risky customers, consider asking for these in exchange for bigger terms.

In practice, setting the limit involves judgment. It should cover the expected outstanding invoices without being so high that a single customer’s failure would hurt you. It often makes sense to involve sales managers in this decision (they know the customer’s plans) and to document the rationale.

Choosing Payment Terms

The payment terms you set determine when and how payment is due. Common elements include the time after invoicing (e.g. “net 30”) and any discounts or penalties. Some common formats are:

Net 30, Net 60, Net 90, etc.: These mean payment is due within 30, 60, or 90 days of the invoice date. Net 30 is perhaps the most common in B2B: it gives the buyer about a month to receive goods, verify them, and pay. Net 60 might be offered for larger purchases or in industries with longer payment cycles (for instance, manufacturers buying capital equipment or distributors handling big seasonal inventory). Net 90 is less common, but you may encounter it with very large projects (e.g. construction, government contracts) where both parties expect slower payments
Early payment discounts (prompt-pay): To encourage faster payment, many suppliers offer a cash discount. A typical term is “2/10 net 30”: the buyer gets a 2% discount if they pay within 10 days; otherwise the full invoice is due in 30 days (This is often read “two ten net thirty”.) Smaller variations are possible: 1/10 net 15, 2/10 net 60, etc. The idea is to give the buyer an incentive to free up cash quickly for you. However, early-pay discounts effectively increase your cost (2% off is like taking a small loan at high interest), so use them when you want to speed cash flow or reward very timely payers.
Cash on Delivery (COD) or Prepayment: For new or risky accounts, you might require payment when goods are delivered (COD) or even in advance for the first order or large orders. Some companies start small orders COD and switch to net terms only after a payment record is built. This shifts risk away from you entirely.
Installment or Milestone Payments: In project-based businesses (construction, B2B services, custom manufacturing), you can break a large invoice into parts. For example, 50% upfront, 25% mid-project, 25% on completion. This isn’t uncommon when the order is too large to expect full payment at the end. It aligns payments with your costs and reduces risk.
Late-payment penalties: Decide whether to charge a finance charge or late fee if terms are missed. Commonly, businesses include an interest charge (e.g. 1.5% per month) on past-due balances, which gives the customer a reason to pay on time and compensates you for the delay. Make sure any late fees comply with local laws.
Form of payment: Clarify acceptable payment methods (check, ACH, wire, credit card). Some companies offer a slight fee for credit card payments to offset merchant costs..

Industry norms: Keep in mind that standard terms vary by sector. For example, consumer goods and many wholesalers typically use net 30; steel or electronics manufacturers might demand net 60 or even net 90; construction contractors often wait 60+ days after project milestones; retailers sometimes have stricter terms (and may even impose payment on approval of inventory). If you operate in a regulated or government-linked industry, contracts may specify terms (e.g. 90 days for government suppliers). Adjust your terms in line with what’s customary so you remain competitive, but never sacrifice your cash flow needs.

Monitoring Accounts and Adjusting Credit

Granting credit is not a one-time decision. You must monitor customer accounts continuously and adjust as needed. Here’s how:

Regularly review accounts receivable aging: Run an AR aging report to see which invoices are 30, 60, 90+ days past due. Aging reports flag slow-paying accounts so you can act early. For example, you might decide that any customer with invoices over 60 days should stop ordering until they catch up.
Stay on top of payments: Automated invoicing and reminders can help. Send invoices promptly and follow up with reminders as the due date approaches. Some accounting systems (or CRM software) automatically send emails for unpaid invoices. Automated credit checks or alerts (e.g. if a bureau notes a change in credit score) can also signal emerging issues.
Adjust limits and terms as needed: If a customer continues to pay well within terms, consider extending a higher credit limit or longer terms to help them grow (and to encourage more business from you). Always do this in writing – update their credit agreement or send a confirmation email. Conversely, if payments start coming in late, tighten up: reduce the limit, shorten the payment window (e.g. from net 30 to net 15), or require partial prepayment on future orders. In extreme cases, you might switch a troubled customer to cash-on-delivery until they reestablish trust.
Use credit insurance or factoring for higher risk: Larger companies sometimes buy trade credit insurance, which pays if a customer defaults. This lets you confidently set higher limits. Another option is invoice factoring, where you sell receivables to a financier at a discount – effectively outsourcing credit and collections. These tools aren’t needed for every business, but they exist as ways to manage receivables risk.

Conclusion

In the end, the goal is balance. Offer enough credit to help customers grow, but not so much that one payment hiccup risks your bottom line. With the right mix of analysis and monitoring, businesses of any size can extend trade credit safely and effectively – fueling sales growth while keeping cash flow healthy.