What would happen if your biggest customer went broke?

Part of running a successful business involves targeting the most lucrative customers, then doing what it takes to keep them loyal and happy.

This strategy is most successful when a company can attract a high number of such customers, spreading the risk of non-payment among them. When a company only has one or a small handful of lucrative customers, relying on them for the bulk of its revenue, this introduces concentration risk.

Concentration risk occurs when a business relies so heavily on that one key customer that it would significantly burden the business if that customer were to pay late or not at all. The damage to revenue and cash flow can create instability for the organisation, which could find itself unable to pay its operating costs including meeting debt obligations and paying staff and suppliers.

The knock-on effects of this, of course, is an inability to secure the labour and resources required to operate, thus creating a vicious cycle in which the business struggles to regain its footing. Ultimately, this can lead to an increased risk of insolvency.

Unfortunately, in many cases, small businesses find themselves so invested in the key customer’s ongoing satisfaction that they may inadvertently neglect other customers or fail to adequately fill the pipeline with new prospects. This can exacerbate the risk.

Furthermore, banks and other lenders can get nervous when they see a business with concentration risk. These financiers often know all too well the risk this can pose, and it can make them reluctant to offer finance at all, let alone at competitive rates.

It’s important for CFOs to clearly understand the risk of relying too heavily on a single customer. The most significant and immediate risk is to cash flow.

However, it is possible to mitigate the risk. There are seven key ways to achieve this:

  1. Insist on long-term contracts to reduce the risk that the customer will switch suppliers unexpectedly.
  2. Allocate resources to grow the customer base, preferably in different industries but certainly with different customers.
  3. Add new or different products that can attract a different customer base as well as gain greater share of wallet with existing customers.
  4. Be alert to the customer’s payment habits and any industry or environmental factors that could cause late or non-payments.
  5. Set payment terms that favour the business rather than the customer and offer incentives for the customer to stick to these terms, reducing the risk of late payments.
  6. Offer a partnership arrangement where the customer covers the costs of some of the business’s capital overheads in exchange for preferential access to products and services.
  7. Take out trade credit insurance to protect the business’s cash flow in the event of late or non-payment. This can also favourably influence lenders’ decisions regarding whether to offer finance and at what rates.

Trade credit insurance can also offer additional benefits. For example, the insurance provider can help with due diligence when it comes to credit-checking customers, which can reduce the chance of trading with unreliable partners. This due diligence can include insights into customers’ debtor management and credit control policies and offer an accurate understanding of the current trade risks. Issues that can affect credit limits need to be identified as soon as possible.

It’s important to remember that the size of a company doesn’t guarantee cash flow and even the largest of organisations can be a chronically-late payer. Checking customer credit histories lets you know if your potential customer has previously defaulted on payments, as well as how likely they are to repay debts on time or take on loans they can’t afford. Routine credit checking helps to ensure that the agreed trade settings are still appropriate for the customer.

If customers fail credit checks, it doesn’t necessarily mean your business shouldn’t trade with them. Instead, you should request a personal guarantee from a financially-sound director or shareholder to ensure that payments will be honoured.

A clear red flag that a customer could present a credit risk is when the customer trades on credit terms. If it does, then it likely has substantial amounts of working capital tied up in accounts receivable, which can be risky if its customers can’t or won’t pay on time. The flow-on effects can damage every organisation in the supply chain, including yours.

Credit insurers will follow up bad debts on your behalf and cover your losses, protecting your cash flow and your ability to operate.

Business success depends on planning carefully. By putting preventative measures in place, you can reduce your business’s exposure to risk when faced with the collapse of a customer.

How good is your credit management?

Get an instant overview of potential areas of trade credit risk for your business with our free checklist. You’ll be able to identify potential gaps within your credit management process and ensure that your businesses is appropriately managing risk and enabling trade by securing your cash flow.

Disclaimer

The statements made herein are provided solely for general informational purposes and should not be relied upon for any purpose. Please refer to the actual policy or the relevant product or services agreement for the governing terms. Nothing herein should be construed to create any right, obligation, advice or responsibility on the part of Atradius, including any obligation to conduct due diligence of buyers or on your behalf. If Atradius does conduct due diligence on any buyer it is for its own underwriting purposes and not for the benefit of the insured or any other person. Additionally, in no event shall Atradius and its related, affiliated and subsidiary companies be liable for any direct, indirect, special, incidental, or consequential damages arising out of the use of the statements made information herein.