Your organization probably takes great care to maintain its financial stability year after year. However, do you consider the financial stability of your vendors? When a vendor has poor financials, you may see issues like a decline in service levels, the termination of products or services and rapid staff turnover. Since these issues can affect your business operations, it’s essential to periodically review your vendor’s financials as a part of your ongoing due diligence.
Evaluating Your Vendor’s Financial Stability in 5 Steps
Here are five recommended steps you can take to evaluate your vendor’s financial stability:
- Obtain the financial report: If the company is public, you should be able to find the form 10-K or audited financial statement online. Request directly from the vendor if it’s a private company.
- Utilize SMEs: Subject matter experts (SMEs) like CPAs should review the report to ensure that you’re getting a qualified opinion on the vendor’s financial stability.
- Ask the right questions: The following questions will reveal a lot about the vendor’s financial health:
- Is the vendor generating enough revenue and/or do they have enough capital to support their ongoing operations? This can significantly guide the vendor’s financial health.
- What is the vendor’s debt-to-worth? This may be challenging to validate, but it’s a critical factor.
- Specifically, what is the vendor’s tangible net worth? If the vendor has a large percentage of goodwill and intangibles, this may imply that they’re unable to convert their assets into capital or liquidity.
- Will the vendor be able to continue operations at their current cash level?
- Prepare an assessment: The assessment should include the balance sheet, income statement, cash flow, key ratios and supporting commentary/conclusion. The analyst/SME should always provide a clear summary conclusion in the assessment, which can provide the key takeaways on what your organization should act on with this vendor based on the financial health and risk level identified.
- Create a financial stability rating: A financial health rating can be categorized into four simple categories – adequate, moderate, need monitoring and intense monitoring. These ratings provide you with consistent and easy to understand results, as well as an overall cadence on how often you should conduct your reviews in vendors that fit in the different rating categories. This should be done on an annual basis at minimum.
Financial Red Flags: What to Do Next
After you’ve evaluated the vendor’s financial stability, you may be wondering what to do if you discover any red flags. Here are some suggestions:
- Request additional information – Ask the vendor for more documentation that can address some of your concerns. This incremental information can help show how the vendor mitigates the risks identified from a financial health point of view. For example, if a vendor’s current liquidity and lack of profitability are red flags your organization identifies, they may provide you with additional information that shows they have either recently received additional outside funding or have easy access to capital to make up for their current liquidity concerns.
- Use your service level agreements – Ensure that your contractual service level agreements are well-defined to address any financial performance clauses. Whether you want to exit the contract or receive some sort of concession, these expectations should be included within your contract.
- Consider an alternate third party – If your current vendor has significant deficiencies, you may want to consider using another third party as a replacement or supplement.
It’s critical to understand your vendor’s financial stability as a part of a robust third-party risk management program. Take these steps to stay informed of your vendor’s financial health which in turn will protect your organization from a variety of risk.