If you're a small business owner, you're likely aware of various risks related to your line of work. One that you may not be familiar with is a high concentration of sales or credit. This threat arises when a small number of customers represent a large percentage of your annual sales or accounts receivable.
But a high concentration of sales and/or credit isn't only risky to the health your business. It can also present challenges when you apply for a business loan.
Concentration of credit
If one customer represents 100% of your outstanding accounts receivable, you have a 100% concentration exposure. Having such high exposure to one customer may create undesirable consequences. The best way to minimize your exposure is by acquiring more customers.
Every situation is different, and bankers look at each case individually. However, banks prefer to make line of credit loans to businesses that have less than a 10 to 15% concentration to any one customer. If you do have one customer that represents a higher concentration but is still a good credit risk, your lender may work with you to help mitigate your total risk.
Concentration of sales
Almost as significant as concentration of credit is concentration of sales. Take your company’s annual revenue and calculate the percentage of sales that come from your largest customers. If any one of them represents more than 15% of annual sales, then you have a concentration of sales for those customers.
Why does your lender care about concentrations of credit and sales?
- It is just a good business practice to diversify your risk by not having a single customer that you can’t afford to lose.
- When you have a single large customer you face the risk that they may take their business elsewhere. If they do, your revenues and profits may go down and decrease your ability to repay a bank’s loan.
- Often companies that service only a small number of customers have narrower profit margins as a result of having large accounts.
Concentration of credit and sales are separate issues. However, they both have the potential to cause your company difficulties. You should manage them carefully, especially if you are planning on applying for a business loan or line of credit.