How to set credit limits and payment terms
Is your company selling professional services? You will at some point of time come across a client who won’t pay their invoices.
Consider the four factors outlined below, and you will minimize your losses. A few small but smart precautions can save your firm huge amounts.
There can be many reasons for a client refusing to pay. Clients might have valid reasons and in such cases, you should focus on finding a compromise that is acceptable to both parties.
That being said, this article deals with setting the right credit limit to minimize risk and losses from businesses who can’t pay or refuse to pay for other reasons.
First a bit of background for you to understand our perspective: At LiteBreeze we provide software development services from our offices in India and Sweden. Our clients are often located in regions that are distant from us – such as the UK, Germany and the US.
Factors that should affect the credit limit
Factor 1: company size, financials and owners
Research company websites and public company registers.
Factor 2: company reputation
We once made the mistake of not researching a client online before extending too generous payment terms. We noticed that previous consultants who had worked with the client had posted comments online about the fact that they never got paid.
Obviously a strong warning signal, which could be found with a simple Google search. So visit your prospective client’s social media pages. Google them. Does their LinkedIn profile seem legit with references?
Factor 3: company location and jurisdiction
Here at LiteBreeze, we have an office in Karlstad, Sweden and we sign contracts through our Swedish business entity. Psychologically, legally, and for other reasons as well, this makes Swedish and EU clients more likely to stick to agreed payment terms.
Factor 4: length and strength of business relationship
Once you’ve worked with the client for a while you can, of course, increase credit limit and payment terms. Especially if there have been few payment delays, few questionable discount requests and you have a great rapport with the client in general.
Don’t forget payment terms and team size
Payment terms and team size often have a higher impact on risk than the credit limit itself:
If the credit limit is €1000, and the payment terms are 10 days, and it takes 5 days to receive an international bank payment, the total due could top: €1000 + 11 business days * 8 hours * 2 developers * €20 per hour = €4520 (15 days – 4 weekend days= 11 business days)
In addition to that, it may take three business days to take the final decision to pause services. It might take another five days to transfer developers to another billable project, risking a total €7080.
Should you demand an advance or retainer?
At LiteBreeze we typically decline high-risk clients. If you are short on clients and consider taking on a high-risk client, demanding an advance/retainer can definitely be a good idea. Be transparent about your concerns with your prospective client. You only stand to gain from transparency. Earnest clients will understand and gladly accept.
Another option is to ask them to pay the first X invoices as soon as they are issued, and ask them to send the payment receipt at the same time. Clients might be keener on this rather than paying a retainer, as they risk less money themselves.
Build rapport and anchor your relationship
This is even more important if your client resides in another country. Add them on LinkedIn (why you should be on LinkedIn). Have a webcam meet before getting started to build rapport. Make sure you have your client’s phone numbers.
What are the benefits for the client?
The payment timeframe is not a zero-sum game where a client wins the longer the payment is put off. Clients have an incentive to pay invoices quickly:
- The client gets larger credit limits in the long run which minimizes administrative hassles.
- The service provider can assign a bigger team to deliver their projects faster.
Ask for information
If you can’t find information on Google, just ask. Example:
We usually run a credit check on all new clients, which we couldn’t do because XYZ is an unfamiliar jurisdiction to us (/your company is a startup). Therefore we unfortunately have to stick to fairly restrictive credit terms.Sorry about having to ask but please do share more details if possible. E.g. if there is an established parent company, financial information, background of owners, LinkedIn profiles etc.Eventually we might be able to relax credit terms and make invoicing less frequent and cumbersome. Thanks for understanding!
Increasing payment terms and credit limits
Sometimes clients will insist on better (longer) payment terms, increased credit limits and faster delivery (bigger team). If you do increase these, remind the client about their responsibilities to reduce the risk of any disputes.
The client’s responsibilities can include: checking progress through time sheet overviews, work plans and deliverables like sprints. If there has been any discount requests, reaffirm that clients should send such requests early and timely and give good specific reasons.
The right credit limit and payment terms have no effect unless you have a team that knows how to follow up on overdue invoices. This is a balancing act between being firm and giving good clients some leeway. Read the guidelines on how to follow up invoices.