Credit limit

A credit limit is the maximum amount of credit offered to a customer. For example, a supplier grants a credit limit of $5,000 to a customer. The customer makes $3,000 of purchases on credit, which reduces the available credit limit to $2,000. At this point, the customer can make additional purchases on credit of $2,000, but must pay down some of the outstanding balance in order to make a larger purchase on credit.

The 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:

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.

Related Courses

Credit & Collection Guidebook