Sales Concentrations and Large Customer Payment Risk

Take a second and think of the name of your largest customer. Now, think about how much that customer owes you. Do you have the figure in mind? Next, imagine that your next call or email tells you that this customer can’t or won’t be paying you. Let that sink in for a minute.  What thought runs through your mind? If you’re like most people, it’s probably “Oh Nooooooooo….” or something worse.

At a certain dollar amount, an unpaid customer balance changes from an irritation to a potentially devastating event as the cash flow gap stretches your business to the breaking point.

Questions to ask

In order to protect your business, ask these questions.

1. How much would a customer have to owe before the unpaid balance becomes a catastrophe?
2. How many accounts do you have that owe that much or more?

Analyze your position

With the answer to the questions above in mind, if the balance from one of those accounts went unpaid, how are you positioned to withstand the loss? Do you have enough cash on hand to cover the raw materials, inventory, labor and other costs that have already been paid? Would you need to liquidate an asset or inject personal money into the company? How much of a shortfall do you project?

How much would you need to sell to replace the money lost in a bad debt? Remember that net profit is where bad debt is repaid. Coface has an online tool to give you the sales figure to out-sell your bad debt. If you don’t increase sales by that much, your business shrank in terms of profitability.

Consider an alternative

Key accounts are a big reason companies use trade credit insurance. By transferring the risk of non-payment to the insurance company, business owners and financial managers get several advantages.

1. The largest portion of their largest asset is protected from loss. Coface research shows that accounts receivable makes up 36% of most company’s assets. Within that pool of receivables, the 80/20 rule always seems to apply. 80% of the outstanding balance owed comes from a small handful of customers. It is these larger-balance customers that create the financial exposure that could wipe out profit or even bankrupt the company. (25% of all bankruptcies are caused by an unpaid receivable balance.)
2. If the capital in a business has been built over many years and the owner(s) are nearing retirement age, protecting large receivable exposures starts to look like life insurance for the business. A large loss could wipe out years of wealth accumulation just at the time when the owner(s) want to transition the business through a sale or generational transfer of ownership. Insuring that exposure is very inexpensive compared with the loss potential.
3. If the business finances receivables through their bank, large balances make up key borrowing assets that are often limited because of sales concentration rules. Banks know that the risk to a business is increased whenever one customer makes up more than 20% of receivables . For more information on using credit insurance to facilitate borrowing, click here.
4. Cash that would otherwise be used to self-insure can be invested in the growth of the business. The ROI of the business is far greater than the earning potential in today’s low-rate environment. The cost of credit insurance is far less than the ROI of the business. Using insurance instead of cash reserves makes financial sense.
5. Hoping it doesn’t happen to you isn’t an option!

Conclusion

Large payment defaults can be catastrophic. Credit insurance is a very cost-effective way to protect against this risk and offers multiple advantages. To learn more, contact me today!

Have you survived a large account loss or know someone who has (or hasn’t!)? Share your story in the comments!