When it comes to your vendors and your vendors’ financial health, there’s one thing you must keep in mind: financial performance is not an event of default. What do we mean by that? In a post-pandemic world, poor financial performance on the part of your vendors is not a “get-out-of-jail-free card” — for either party, and it’s certainly not an accurate predictor when it comes to financial health. Organizations need to perform an analysis in order to properly forecast what steps to take next. That means a focus on financial health, rather than performance.
Let’s take a look at some ways to do just that. Here are 4 tips you need to know:
1. Treat the Majority of Your Vendors as High Risk
Ultimately, a financial analysis isn’t really about the numbers. It’s also not about fancy language. It’s about making a decision, and in order to make a decision that’s right for your organization, you need to know if you’re getting the right data. However (spoiler alert), in the current environment, one wracked by uncertainty and unemployment, you’re simply not going to get meaningful data anytime soon. In a widespread pandemic or disaster scenario, we cannot confidently say we know anything about the financial health of our vendors, and the truth is, most of them do not know their health either.
Here’s what we can count on: Typical financial health ratings will flip. This means that the percentage of vendors that once needed intense monitoring (likely a smaller percentage of total vendor spend) will be closer to the number of vendors who were previously in the “safe zone.” Translation: you will have lots more problems.
The best bet in this situation is to treat the majority of your vendors as high risk with a need for intense monitoring. Remember, this is about making a management decision quickly, so don’t waste unnecessary time by making an analysis overly complex.
2. Review the 10-K Form
For the vendors who are publicly traded companies, reviewing the vendor’s 10-K form is really what can help provide a comprehensive look at where they sit financially. When a health crisis forces the majority of an economy into a standstill, controls put in place prior to pandemic or global crisis are likely far from working optimally, but a 10-K can help fill in some knowledge gaps and can give great context for hard numbers. If the vendor isn't a public company, request a financial statement.
In the 10-K, here’s what you’ll want to look for:
- Risk Factors: These are outlined in detail with special note to any regulatory action that may have occurred. (Example: Credit risk of major clients, change in bond rating).
- Legal Proceedings: Scan for any pending lawsuits or legal actions, along with settlement details. (Example: Memorandums of Understanding or Department of Justice issues).
- Auditor Feedback: Look for opinions on going concern, subsequent events, comprehensive income, assessments around internal controls and any areas of concern. (Example: Material uncertainty, renegotiation of debt covenants, changes in major shareholders).
3. Emphasize the SLA
During or after a major crisis, every vendor has a sound legal reason for non-performance on SLAs. But don’t let the domino effect of declining financial health surprise you.
Ultimately, this domino effect directly impacts your service levels, from response time to security efforts. Use your service level agreements to your advantage. Contracts often go through multiple rounds of review, but rarely are they (or their compliance) brought to the attention of executive management. When in doubt, escalate.
4. Revisit Your Existing Information
When we really find ourselves in the weeds, all we can do is relook at the information we already have. When it comes to reviewing financials in a pandemic world, methodically work through your list category by category. Start with the ones that were in hot water prior to the crisis, then move onto the moderate and low-risk categories.
Here are a few of the major things you’ll want to ask yourself about each:
- Is the vendor making money? (e.g. what are the number of new sales from the last two months?)
- Do they have sufficient capital to support their ongoing operations? (e.g. how many employees have they terminated or furloughed?)
- What does their 15-month forecast look like?
- Have we begun to see signs of the domino effect?
- What about subsequent events?
At the end you should really have two main buckets. In the first bucket, you’ll have the vendors who are currently in poor financial health, but from analyzing the information above, have a strong outlook. In the second, you’ll have vendors who also have a poor current financial health but show a low probability to survive.
Remember, in an economy crippled by crisis, all bets are off. You’re likely not going to get accurate timely financial information. Use what you do have, lean on your SLAs and communicate as frequently and clearly as possible with your vendors.
Watch for key signs of declining financial performance. Download the infographic.