Vinu:  Manu, a borrower has reported strong sales and profits. But nearly 70% of the sales come from one customer. Should the bank be concerned?

Manu: Yes. Strong financial performance is important, but excessive dependence on one customer creates concentration risk.

Vinu: What exactly is customer concentration risk?

Manu: It is the risk that a borrower depends heavily on one customer or a small group of customers for sales, cash flow and profitability. If one major customer stops purchasing or delays payment, the borrower’s business may be seriously affected.

Vinu: How do we measure this dependence?

Manu: We can calculate the customer concentration ratio:

Sales to a Major Customer ÷ Total Sales × 100

Suppose the borrower’s annual sales are ₹10 crore and sales to the largest customer are ₹6 crore. The concentration is 60%.

Vinu: Is 60% considered risky?

Manu: Generally, yes. But the percentage should not be viewed in isolation. The banker should also examine:

Vinu: What could happen if the major customer is lost?

Manu: Sales may fall suddenly. Inventory may remain unsold, receivables may get delayed, production capacity may remain idle and cash flow may weaken. The borrower may then struggle to pay suppliers, employees and bank instalments.

Vinu: Can a profitable borrower still face repayment problems because of this?

Manu: Certainly. Profit shown in the financial statements does not guarantee timely cash flow. If a major customer delays a payment of ₹1.50 crore, the borrower may face an immediate working capital shortage even though the business is profitable on paper.

Vinu: Should we also examine receivables customer-wise?

Manu: Absolutely. The debtor ageing statement should reveal:

A large customer concentration combined with delayed receivables is a serious warning sign.

Vinu: What if the borrower says that the major customer is a reputed company?

Manu: A reputed customer reduces default risk, but it does not eliminate concentration risk. That customer may change suppliers, renegotiate prices, reduce orders, shift production or alter its procurement policy.

Vinu: Does dependence on a large customer also affect bargaining power?

Manu: Yes. A dominant customer may demand longer credit, lower prices or stricter quality terms. The borrower may accept these conditions because losing the customer could significantly affect the business. This can gradually reduce profit margins and cash flow.

Vinu: How can we verify whether sales are genuinely diversified?

Manu: We should examine:

Vinu: Why should related-party sales be checked separately?

Manu: Because apparent diversification may not be genuine. The borrower may report sales to several entities, but those entities could belong to the same group or promoter. Economically, the business may still depend on one controlling group.

Vinu: What other questions should the banker ask?

Manu: The banker should ask:

Who are the top five customers?

Vinu: Is customer concentration equally risky in every industry?

Manu: No. In some industries, supplying to a few large buyers is common. For example, an auto-component manufacturer may depend on a limited number of automobile companies. In such cases, the banker should compare the borrower’s concentration with industry practices and assess the strength of its supply arrangements.

Vinu: What if the borrower has maintained the same major customer for ten years?

Manu: That is a positive factor, particularly when the payment record is good and the relationship is supported by contracts or repeat orders. However, the bank should still examine whether the borrower has a contingency plan.

Vinu: What safeguards can the bank consider when concentration is high?

Manu: The bank may:

Vinu: So customer diversification is not merely about increasing the number of buyers?

Manu: Correct. Genuine diversification means that sales, receivables and cash flows are reasonably spread across independent and financially sound customers.

Vinu: What is the key credit appraisal takeaway?

Manu: A borrower with diversified customers is generally better placed to withstand the loss or delayed payment of any single buyer. Therefore, bankers should not assess only how much the borrower sells—they must also examine to whom the borrower sells, how much each customer contributes and how reliably the money is collected.

To learn more about Banking & Financial related topics

We invite you to join our Diamond Membership
Check - https://courses.carajaclasses.com/courses/Diamond-Membership-6305fad1e4b0cccc82d610be
For Special Discount on Diamond Membership 
Connect with us  - https://wa.me/919025100249?text=DLM