Ever since launching our online two-course series “Finance For Strategic Procurement,” I’ve had many practitioners approach me about the topic and its importance in today’s modern procurement world. This week, I separately met with executives at two totally unrelated companies who learned from me that they were making the same mistake.
What was that mistake?
Well, it relates to the evaluation of supplier financial health. I introduced them to four methods of evaluating supplier financial health. One of those methods involved using the Altman Z-Score.
Have you ever heard the phrase “I know enough about it to be dangerous?”
Well, that applied in both of these situations.
You see, the Altman Z-Score calculation has three variations: one used for publicly-held manufacturers, one used for privately-held manufacturers, and one used for non-manufacturers. Each Z-Score calculation is performed using slightly different coefficients and variables to arrive at a number used to compare against a scale that determines the financial health of the supplier.
Well, not only is the calculation different for each of the different variations, but the scale against which a supplier’s Z-Score is compared is different for each variation. So, beyond just using the wrong calculation, by using the wrong variation, you could be getting a totally opposite reading on the financial health of a supplier!
For example, let’s say you calculated the Z-Score for a publicly-held manufacturer as 1.7. But let’s also say that you used the comparison scale of the variation for non-manufacturers.
The comparison scale of the variation for non-manufacturers indicates that a 1.7 puts the supplier right in the middle of the “grey zone.” This means that there is not a severe likelihood of imminent bankruptcy.
But what does the comparison scale for the publicly-held manufacturer variation – the correct variation, in this case – say?
It says that a score of 1.7 puts the supplier in the lowest category, meaning bankruptcy has a high likelihood. If you don’t apply the right variation to the type of supplier you are evaluating, the Altman Z-Score will not work!
Obviously, Finance For Strategic Procurement (Part II, specifically) covers how to correctly apply the Altman Z-Score for each type of supplier. Though I know that not enough procurement professionals utilize the excellent tool that the Altman Z-Score is, I didn’t realize that applying the wrong variation appears to be a very common mistake among those that do attempt to utilize it.
Perhaps that’s what happens when googling is used instead of getting authoritative purchasing training: learning enough to be dangerous. And, make no mistake, miscategorizing a healthy supplier as a financially distressed supplier or failing to recognize a supplier’s impending bankruptcy are both dangerous procurement mistakes.
“Epic fail” kind of mistakes.
To Your Career,
Charles Dominick, SPSM
President & Chief Procurement Officer
Next Level Purchasing, Inc.
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