Credit Utilization Ratio

What is a Credit Utilization Ratio?

A credit utilization ratio is the percentage of the total available credit your company uses. The total credit ratio is determined by looking at the proportion of debt owed as a proportion of its credit limit.

The credit utilization ratio formula is:

Credit utilization ratio = Total outstanding debt/Total credit limit

Let’s take an example of two customers with debts of $5,000 and $10,000. Currently, you’ve only paid $2,000 total for each, so you have a $11,000 total outstanding debt. Your total credit limit is $20,000. As a result, you have a credit utilization ratio of 55%.

Why Credit Utilization Ratio Matters

An optimal credit score depends on a range of factors, including your industry, company size, the age of your business accounts, and payment history. The manufacturing and construction industries tend to have higher credit utilization rates whereas the technology and software industries tend to have lower ones. Although it also depends on the factors mentioned above, the recommended credit utilization ratio should typically be 30% or less as it could affect your credit score.

It is an important component of your credit score. Up to 30% of the credit score consists of your credit utilization ratio, according to most models from top credit bureau agencies. There are exceptions, however. The Dun & Bradstreet PAYDEX Score, for example, focuses on payment history rather than debt levels.
It signals your creditworthiness. Lenders and credit companies use this score to determine your dependence on credit and the risk you pose to suppliers. They also use it to determine the interest rates at which they provide loans to your business.
It can be quickly improved. While other factors related to your credit score take years to change, your credit utilization score can be tweaked more easily.

Managing and Improving Your Credit Utilization Ratio

Since your credit utilization ratio is such an important element in your credit score, it’s critical to follow best practices to maintain the best credit utilization ratio possible and demonstrate that you manage your debt properly.

Here are a few tips:

Pay debts on time. Once your company is earning revenue, consider using some of it to pay off debt, especially those earning higher interest. Pay at multiple times during the month to coincide with when your balance is reported to the credit bureau. Having lower balances several times during the month helps lower your credit utilization ratio.
Request an increase in your credit line. If you see that you are using a high percentage of your credit regularly, request an increase so that your credit utilization ratio decreases. You can also do this if you don’t need additional credit for spending. Many creditors will even raise your credit line automatically if you have a history of good credit.
Keep multiple lines of credit open. If you’ve paid down your account balance on one credit or debit card, maintain it. Having multiple lines of credit, even if you aren’t using them now, factor into your total credit limit. As a result, these can help optimize your credit utilization ratio.
Monitor your credit utilization ratio regularly. This score can change frequently as your company’s outstanding debt and credit limit fluctuate. By keeping track of your credit utilization ratio on a regular basis, you can address any potential issues before they become a more serious concern.

How Gaviti Helps Monitor and Manage Credit

Gaviti’s A/R management invoice-to-cash solution optimizes the entire account receivables process, from invoicing to disputes and cash application. All of these modules work together to gather data and insights to optimize the entire A/R invoice-to-cash lifecycle.

Its credit management and monitoring module includes:

Credit application management. Send both current and potential customers online credit application forms with a more efficient process that includes streamlined form submission, approval, and ongoing monitoring.

External and internal data integration. Gather data from different external sources such as credit agencies and integrate it with A/R platform data such as customer payment history to gain insights related to credit risk associated with each customer.

Credit limit management and monitoring. Define and manage credit limits for your customers based on creditworthiness and risk assessment to proactively defend against credit risks. With visibility into credit limits, utilization, and available credit, you’ll make better decisions related to extending or modifying credit terms.
Real-time credit risk alerts. Set alerts that are triggered according to a predetermined threshold or other criteria so that you can prioritize collections efforts and take proactive measures to reduce bad debt.
Risk assessment. Defining the criteria that align with your specific business needs to ensure a targeted and effective credit management strategy. That could include payment behavior thresholds, credit score ranges, or a range of other risk factors.
Reporting and analytics. Track metrics such as DSO (Days Sales Outstanding), credit risk exposure, and credit utilization on a regular basis to improve your credit management strategy, optimize credit decisions, and drive financial success.

Want to learn more about how you can manage and monitor your credit with Gaviti while automating and streamlining the entire A/R process? Get a demo today!