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Managing risks is fundamental to building supply chain resilience and business continuity. There are numerous risks to evaluate, monitor and consider when managing your supply chain. These risks can come in many forms, from natural disasters to civil unrest to government regulations.
One of the most important, yet often overlooked risks is financial risk.
Unmitigated supplier financial risk can lead to significant disruptions and devastating impact to your supply chain and business continuity. Fortunately, many financial risks are predictable and preventable—with the right strategies and tools in place.
Supplier financial risk is the level of exposure that comes as a result of working with a particular supplier. In other words, supplier financial risk encompasses the financial health of your suppliers, with a focus on identifying and mitigating financial threats to your business.
There are many factors to consider when determining financial risk, but gaining a complete picture of financial risk can be difficult—especially when that information is limited or coming directly from the supplier.
However, there are signs that can warn of troubled waters ahead. Some risks develop gradually and can be detected over time, while other indicators may be virtually undetectable and arise suddenly.
For example, when suppliers are experiencing financial challenges, you may experience
These issues can be helpful signposts to indicate current or emerging financial issues with your suppliers. But how can you assess new or potential supplier financial risk?
There are several best practices and key metrics to look at when gauging the potential financial risk of a supplier.
The information required is sometimes available publicly or in reports published by the supplier, or can be requested and provided by the supplier. However, any data provided by the supplier should be reviewed and validated to the extent possible as supplier-provided information may be biased or incomplete.
As you evaluate new suppliers, pay attention to the following key financial metrics:
Supplier financial statements can give you insight into the supplier’s business operations, growth, and financial health over time. This includes revenue, historical revenue growth, cost of goods, gross profit, EBIT, and other important metrics.
Financial ratios draw key comparisons between metrics found within financial statements and can be a useful tool for evaluating both short- and long-term financial performance and uncovering trends or problems ahead. As you assess supplier financial risk, keep these ratios in mind:
Current ratio, also known as working capital, measures the capability of a business to meet its short-term obligations within a year. Current ratio considers the weight of total current assets versus total current liabilities. This indicates the financial health of a company and how the business can maximize the liquidity of its current assets to settle debt and payables.
The better a company’s working capital, the less likely it will need to borrow money to fund its operations. If a supplier has a poor current ratio, that could indicate inefficiencies in operations and potential disruptions of supply if funding isn’t secured.
Price to Earnings ratio (PE Ratio) is a measure of the share price relative to the annual net income earned by the firm per share. PE ratio shows current investor demand for a company share. It is calculated as share price divided by earnings per share.
Organizations like D&B create scores that provide a credit rating, as well as other important financial ratings, based on historical behavior of the organization and can provide helpful information regarding how reliable they are as a supplier. A poor credit history can indicate cash flow problems, inconsistency, and bad management, which can indicate a riskier supplier relationship.
Company acquisitions and subsidiary relationships add another layer of financial complexity and potential risk to your supply chain. Acquisitions can disrupt supplier relationships, service and quality threatening business continuity and performance. Similarly, supplier subsidiaries introduce additional levels to your supply chain with financial risks of their own.
As you evaluate your suppliers, it’s important to review your suppliers’ subsidiary relationships as well as current or planned acquisitions to get a full picture of your suppliers’ financial landscapes.
Keep in mind that strong financial metrics in one area can mask problems elsewhere, so it’s important to review the financials together for a complete picture.
The metrics above are extremely helpful in understanding financial risk, but all this data tells the story of what already happened. And while changes in that data can start to give an idea of what may happen in the future, it’s usually incomplete.
That’s why it’s important to dig a little deeper to assess and monitor risk indicators that are less obvious. This includes
These metrics are usually not highlighted in news stories or articles, but they can begin to signal potential financial trouble. Learning about these early on can help you create alternative mitigation strategies or provide the opportunity to reach out to your supplier to learn more about the situation.
Direct financial statements and ratios are important metrics to follow. However, it’s equally important to consume data that may be viewed as non-financial, but can be a leading indicator of financial risk and, ultimately, negative impact to you and your business.
Many of these changes will not be highlighted in news or may not even be found with in-depth google searches. And by the time you’ve reached out to your supplier, it can be too late to make the decisions needed to avoid disruption or impact.
Learn more about supplier intelligence platforms here.
