Ridgeline Fasteners: The $300,000 Limit Request Behind an Over-Limit Balance
Ridgeline Fasteners Inc. is a Toronto distributor with annual sales of $28 million. Harman Metalworks has been a customer for six years and holds a $75,000 limit on terms of 2/10, net 45. Harman's purchases are running at $1.6 million a year, and its balance has averaged $185,000 for eleven straight months - every month over limit, each one released verbally by the previous credit manager. Average days to pay is 52, and Harman takes the discount about 40% of the time. There have been three NSF returns in eighteen months, none in the last nine. Harman now wants the limit raised to $300,000 so it can bid a component-supply contract with a national OEM worth roughly $950,000 a year; the OEM pays Harman on 60-day terms and requires Harman to carry two months of prebuilt stock. Harman's statements show revenue of $14 million, a 6.1% EBITDA margin, a current ratio of 1.28, and a demand operating loan secured by a PPSA registration over all assets. The sales director has already promised an answer by Friday.
1. Quantify the exposure the requested limit creates and decide whether to approve, decline, or approve with conditions. Show your arithmetic.
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Quantify before deciding.
- Existing exposure: average balance $185,000 against a $75,000 limit - the file is already 2.5x over limit. The real risk is not the new contract; it is that limit discipline has been absent for a year.
- New volume: $950,000 / 365 x 60 days = $156,000 average receivables if Harman pays exactly on terms. At its actual behaviour (52 to 60 days on current business, likely slower once the OEM stretches it), assume 75 days: $950,000 / 365 x 75 = $195,000.
- Combined peak: $185,000 + $195,000 = $380,000, above the $300,000 requested. Prebuild stock also means Harman's own cash is tied up in inventory, which slows payment to Ridgeline, not speeds it.
Decision: decline $300,000; counter at $200,000 with conditions. A $300,000 limit would be breached by the modelled peak in the first quarter of the contract.
Conditions to attach:
- Personal guarantee from the owner plus a current signed personal net worth statement.
- A written clean-up covenant: balance below $100,000 for ten consecutive days each quarter.
- Monthly AR/AP ageing and an inventory report; no further over-limit releases without written manager approval logged in the exception file.
- Confirm the OEM's payment behaviour - if it is a slow payer, require a letter of credit or credit insurance on the OEM receivable specifically.
- Split shipments: first release at the existing limit until three invoices clear.
Approving the same limit with no structural protection simply repeats the failure that produced the $185,000 balance.
2. Harman's controller calls the 2/10 net 45 terms 'basically free money' because they always pay within two months. Test that claim with numbers and explain what the answer tells you about the account.
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Cost of forgoing the discount (the standard formula compares the discount forgone with the extra days of credit taken):
Cost = (discount / (1 - discount)) x (365 / (net period - discount period))
= (2 / 98) x (365 / 35) = 2.0408% x 10.4286 = 21.3% per annum
The controller's framing is backwards. Paying on day 52 instead of day 10 buys 42 extra days of credit at an annualized cost of 21.3%. That is well above any plausible borrowing cost for a $14 million fabricator, so the discount is not free money - it is expensive money being declined.
What it means for the credit file:
- Harman takes the discount only 40% of the time, so the blended cost of its trade credit across the Ridgeline balance is roughly 0.6 x 21.3% = 12.8%, still expensive. The pattern points to a cash-constrained borrower that pays opportunistically rather than a sophisticated treasury operation.
- A company that cannot fund 21.3% has weak liquidity, which is consistent with the three NSF items and the 1.28 current ratio.
- Ridgeline's own carrying cost on the incremental $195,000 is trivial by comparison (about $14,000 a year at 7%), so the decision should be driven by default risk and concentration, not by the cost of funds.
Use this in the conversation with sales: the customer is telling you through its payment behaviour that cash is tight, whatever the income statement shows.
3. The over-limit releases were made verbally by the previous credit manager. What control failure does this represent, and what specific policy changes would you put in place?
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The failure is not the over-limit balance; it is undocumented discretionary authority. Once a limit can be exceeded on a verbal promise with no record, the limit stops being a limit. Three consequences follow:
- No audit trail - there is no way to see who approved what, on what basis, or whether the promise was kept.
- No trigger for review - an account drifting from $75,000 to $185,000 should have forced a full re-underwriting at month two. Nobody saw it because nothing was recorded.
- Precedent - the account now expects automatic release, so any future hold becomes a relationship problem rather than a credit decision.
Policy changes:
- All over-limit releases require a written request (email is fine) and a documented decision, including an expiry date - typically 10 business days.
- Set a hard authority matrix: collector up to 5% over limit for 5 days; credit manager to 25% for 15 days; director above that. Anything beyond goes to a monthly exception committee.
- Program the ERP to block order release beyond the approved tolerance so a release is a deliberate act, not the default.
- Report the exception log monthly with three metrics: count of releases, dollar value, and percentage of promises kept. The last one is the real test.
- Trigger a mandatory limit review whenever a balance exceeds the limit twice in a rolling six months.
The point is to make discretion visible and time-limited, not to remove it - a distributor needs the ability to release an order on a Friday afternoon.