Customer Concentration & Business Value | IBV™

Revenue concentration is customer revenue divided by total revenue for the same period. Use consistent treatment of GST, rebates, credits and intercompany sales. Compare the largest account, the largest few accounts and the remaining customer base over several periods. Monthly figures reveal seasonality and project completions that a single annual percentage can conceal.

Gross-profit concentration asks a different question: how much of the business’s gross profit comes from that customer? Calculate customer gross profit using revenue less consistently allocated direct costs, then divide it by total gross profit. Explain allocation limitations. If delivery labour is recorded inconsistently between customers, an apparently precise ranking can be misleading. Gross profit is not automatically the cash contribution lost when work stops.

Receivables concentration measures the customer’s outstanding balance against total trade receivables at a specified date. Review ageing, disputes, subsequent receipts and credit notes alongside it. A large balance may reflect an invoice raised yesterday or persistent late payment. Neither revenue share nor gross-profit share tells you whether the business can fund wages while waiting for that account to pay.

A signed agreement is evidence, but its value depends on its terms and how the parties behave. Review remaining duration, termination rights, minimum purchase commitments, price review provisions, service requirements and remedies. An agreement that allows immediate termination without committed volumes offers different protection from an enforceable purchase obligation, even if both carry the same expiry date.

Renewal deserves its own assessment. Has the customer exercised extensions before? Is a competitive tender approaching? Who controls the option, and can the supplier recover wage or material increases? Examine correspondence and purchasing history rather than assuming that a long relationship guarantees another term. Equally, an unsigned relationship is not necessarily worthless where repeat behaviour and operational integration provide credible evidence of continuity.

Transaction structure matters too. Assignment provisions, change-of-control clauses and customer consent requirements may affect what can transfer. Australian Government ownership-change guidance identifies transfers of leases, permits, licences, records and assets as ownership-change tasks. Have the legal adviser assess the relevant customer agreements; a valuation assumption cannot substitute for required consent.

Consider Harbour Components, an entirely fictional supplier. Annual revenue is $4 million and direct costs are $2.4 million, leaving gross profit of $1.6 million. Customer Group A comprises two accounts under common control. Together they generate $1.2 million revenue and incur $600,000 direct costs, producing $600,000 gross profit. The remaining customers generate $2.8 million revenue, $1.8 million direct costs and $1 million gross profit.

Group A therefore represents 30% of revenue: $1.2 million divided by $4 million. It represents 37.5% of gross profit: $600,000 divided by $1.6 million. At the valuation date, its $180,000 receivable forms 45% of total trade receivables of $400,000. These percentages answer different questions. None establishes a market-standard discount, a probability of departure or an expected bad debt.

Assume operating expenses below gross profit are $1.1 million, including a commercial replacement wage for the owner’s work. Maintainable EBIT before a customer-loss scenario is therefore $500,000. For illustration only, suppose all Group A work ceases, the full $600,000 of associated direct costs can be avoided, and a further $100,000 of operating expenses can be removed. Remaining revenue is $2.8 million, remaining direct costs $1.8 million and remaining operating expenses $1 million. EBIT becomes zero.

The $500,000 decline reconciles to lost gross profit of $600,000 less $100,000 saved operating expenses. It is not a 30% earnings decline simply because revenue concentration was 30%. If labour cannot be released immediately, short-term losses could be greater. Redundancy costs, notice periods, replacement sales and transition spending would need separate modelling. These are invented scenario assumptions, not predictions about actual suppliers.

The $180,000 receivable also needs separate treatment. Customer departure does not automatically mean non-payment. Analyse collectability and timing using evidence; do not write off that balance merely because the scenario removes future orders. If a specific impairment is justified, reconcile it with working capital and equity adjustments so the same loss is not deducted twice.

Customer analysis can affect maintainable earnings, forecast cash flows, the assessment of risk and transaction assumptions. It does not mean every mechanism should be applied at once. If the forecast already includes a specific lost contract and its associated costs, an additional blanket penalty for that identical loss may duplicate the adjustment. Explain what uncertainty remains after the cash-flow assumptions.

A cash-flow approach can compare retention, reduced-volume and replacement-work cases where credible forecasts exist. The assumptions need evidence about margins, timing, capacity and the cost of winning replacement business. Do not attach arbitrary probabilities simply to produce a neat weighted average. Where evidence is limited, a clearly labelled sensitivity range may communicate uncertainty more honestly.

An earnings-capitalisation approach also needs a transparent connection between sustainable earnings and the risk assessment. Avoid presenting an invented concentration threshold or a fixed haircut as accepted market practice. Strong integration, diversified decision-makers and effective succession may support continuity; unresolved termination exposure and owner-only relationships may weaken it. The conclusion depends on the combined evidence, not the largest percentage alone.

The report should identify its purpose, valuation date, assumptions, information limitations and intended users. APESB guidance on valuation services describes APES 225 valuation engagement categories and member reporting and documentation obligations. IBV voluntarily aligns with APES 225; it is not bound by the standard as a mandatory member requirement.

IBV does not offer expert-witness or court-appointed engagements. For an agreed non-litigious purpose, the useful outcome is a reasoned explanation of customer economics, continuity and exposure, not an unsupported punishment for having successful major accounts. Discuss the available evidence and required scope before commissioning the work.

To connect these risks with sustainable profit, read our normalised earnings guide. Confirm the valuation purpose, intended users and information available before relying on a report.