A credit limit is the maximum amount of credit offered to a customer. A credit limit is used to limit the amount of loss that a business will sustain if a customer does not pay. The amount of a credit limit is established by the credit department. The amount of the credit limit is based on a number of factors, such as:
- A customer’s credit score, as calculated by a credit rating agency.
- The customer’s payment history with the company.
- The customer’s financial results and financial position, as described in its financial statements.
- The presence or absence of any personal guarantees or other collateral.
The credit department may find itself under pressure from senior management or the sales manager when a customer wants to place an unusually large order, where they want the credit limit to be increased in order to record a large sale. While doing so can enhance reported revenues, it also increases the risk of incurring a large bad debt loss.