On an ongoing basis entrepreneurs should be aware of the ratio between the size of their top customers (or clients) and their business’ total revenue. All it takes is a simple division computation to reveal a customer’s relative size in terms of gross revenue. If calculated properly, a customer concentration may be confirmed.
The entrepreneur may have a customer concentration risk if one or more of their customer’s total revenue for the year represents 8% or more of all its customers’ revenue for the same year. To many entrepreneurs this concept may sound counter intuitive as they feel the more business done with one customer the better. And while it is generally good for customers to increase their purchases of goods and services with a business, unless the remaining customers do so in similar fashion, the growing concentration of revenue from one (or more) customer(s) creates risk to the entrepreneur.
How to calculate customer concentration
Divide the revenue from your top customer by the total gross revenue of your business in a given year.
- If this amount is less than eight percent (0.08), you do not have a customer concentration risk.
- If this amount is equal to or greater than eight percent (0.08), you have a customer concentration risk with this customer.
- Repeat the calculation with each of your customers using their gross revenue one-by-one from the greatest to least gross revenue in a given year until the calculation is less than eight percent (0.08).
- Every customer with gross revenue which exceeds eight percent (0.08) of your business’ total gross revenue represents a customer concentration risk for your business.
Determining if a customer concentration exists in a business is an important part of the exit planning process for one simple reason. When selling a business, the savvy business buyer will determine if one or more customer concentration risks exists and if so, he will discount his offer price.
Determining if a customer concentration exists in a business is an important part of the exit planning process.
Learn more about how to manage the risks associated with customer concentration.
Holly also founded ExitPromise.com and to date has answered more than 2,000 questions asked by business owners about starting, growing and selling a business.
Latest posts by Holly Magister, CPA, CFP
- How to Prepare for Due Diligence When Selling a Business - February 12, 2019
- DBAs, Trademarks & Other Tools To Help You Grow A Valuable Business - October 30, 2018
- Business Broker Fees and Other Selling a Business Expenses - October 10, 2018