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Assess Supplier Financial Risk Now!

PurchTips - Edition # 163

By Charles Dominick, SPSM


Can Your Suppliers Survive The Credit Crunch?

Stock markets are at 5-year lows, banks have failed, and lending practices have tightened. Governments are promising intervention, but will it be fast and effective enough to prevent the global credit crunch from claiming some of your suppliers? Use this three-step model to assess your supplier's financial risk now to prevent a severe supply disruption later.

Step 1: Identify Your Critical-To-Operations Suppliers. Make a list of all the spend categories where you are sole sourced. Rate each spend category on the Difficulty and Time required to find and qualify a new supplier. Does the time to find and qualify a new supplier exceed your normal inventory levels? If yes, you have identified an immediate threat to operations if the supplier fails.

Step 2: Evaluate Supplier Financial Risk. Insufficient capital is a leading cause of supplier failure. Aging payables, slower inventory turnover, delayed expansion plans and a decrease in available credit are additional early warning signs of supplier financial risk. Liquidity ratios like the Current Ratio are good indicators of financial solvency because they measure your supplier's ability to pay short-term debts.

Determine your supplier's Current Ratio by dividing Current Assets by Current Liabilities. These figures are easy to get online for publicly-held suppliers but you may have to use expert negotiation skills to persuade privately-held suppliers to disclose them. As an example, if your supplier has $750,000 in Current Assets (cash, receivables, inventory, etc) and $900,000 in Current Liabilities (debts due within one year) then their Current Ratio would be 0.83. A common rule of thumb is that a Current Ratio of 1.5 or greater indicates the supplier can sufficiently meet near term operating needs.

Step 3: If Necessary and Practical, Help Your Supplier Survive. If you determine that a key supplier is on the verge of failure, your options include finding a new supplier, buying more stock than you usually do to secure your supply while infusing the supplier with cash, helping the supplier locate sources of capital through your company's bank, or even recommending that your company consider investing in or buying the supplier.

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