Customer Concentration: a Worked Example

A long customer list makes revenue behave like an average. One lost account costs a small slice of the year, and another account usually turns up to fill it. Concentration takes the averaging away. The loss becomes a single event that arrives whole, on a date someone else chooses, and a forecast that assumes the revenue continues is resting on another company's decision.

The damage also travels beyond the income statement. The same customer usually dominates the debtor ledger, so the receivables supporting an overdraft shrink when the account goes. If plant was bought to do that customer's work, the plant loses value at the same moment. The cash flow and the second way out then weaken together, and that link is what separates a concentrated borrower from one that is merely small.

Three details change the reading. Customers under common ownership are counted as one, because they make one decision. Shares are compared over three years, since an account that has doubled says something a single year cannot. And revenue is only one lens: a large low-margin account may cost less than its sales suggest, while a slow payer can dominate the ledger at a modest share of revenue.

The figures rarely come from the accounts. The major-customer disclosure in the international segment standard is triggered at 10 per cent of revenue, but it reaches only entities whose debt or equity trades in a public market, or that are filing to issue there, and the customer need not be named. A private mid-market borrower's accounts usually show nothing of the kind, so the lender asks for three years of sales by customer and reads the contracts itself.

A maker of wiring harnesses for truck and bus builders, constructed for this page like every figure in it, has revenue of US$40m, of which one truck assembler buys US$18m and the five largest customers US$30m. EBITDA is US$7.0m. It asks for a six-year term loan of US$12m, repaid at US$2m a year, with first-year interest of US$0.9m. The assembler's work earns a contribution margin of 30 per cent.

That arithmetic is the same whatever the contract says. What the contract decides is how long the business has before it arrives and what is left when it does. Suppose the assembler gives notice on the day the loan is drawn, under two versions of the same agreement. In version B the buy-back proceeds prepay the loan and the balance is repaid over the remaining four years at the same rate.

The share is 45 per cent in both. In version A the lender has about four months' warning, and the tooling that secures part of the loan fits one customer's trucks and might fetch US$0.5m from anyone else. In version B the borrower has two years to replace the work and receives cash that shrinks the debt. The percentages and terms belong to the example and are not offered as a market norm.

A concentration limit is the lender's response rather than the borrower's condition: a cap written into a receivables facility, or into the bank's own book. A ledger can breach the cap in a business whose sales look well spread, if one customer pays slowly. Supplier concentration is the mirror image, where the loss arrives as stopped production or a sudden price rise instead of missing sales.

The customer's own credit is a separate question. A very strong customer lowers the risk of an unpaid invoice and says nothing about whether it will renew, bring the work in-house or add a second source. Lenders read both, and a borrower who answers the first by pointing at the customer's size has not yet answered the second.

DEFINED IN ONE PARAGRAPH → · THE MERIDIAN CONCENTRATION DRILL → · DEBT SERVICE COVER →

Concentration often changes the shape of a loan before it changes the answer. A lender may keep the term inside the contract's life, amortise faster while the contract runs, advance less against the one debtor, or make the loss or non-renewal of the contract a review event. It may require notice of any termination letter the day it arrives. Trade credit insurance can cover the customer's failure to pay; it does not cover a contract that simply ends.

The borrower's best evidence is on paper: the contract itself, the renewal history, what the customer would have to do to replace the supplier, and the pipeline that would fill the gap. The book takes the reading of a business further in How Bankers Think. A one-minute version of the question sits in the In-Tray.