What Is Vendor Financial Risk?

Assessing the financial risk of your vendors is one of the best methods to safeguard and ensure your own organization’s financial health. You may already have a good idea what encompasses financial health, but perhaps the concept of vendor financial risk may be a bit new. So, let’s break it down a bit further.

Understanding Vendor Financial Risk: What You Need to Know

Truthfully, financial health and financial risk go hand-in-hand. However, just because a vendor may appear healthy on paper, doesn’t mean there aren’t some underlying elements of financial risk. No organization is fully immune from risk, and that includes those related to finances as well.

By definition, financial risk is the likelihood your organization could lose revenue due to a relationship with an organization with unstable financial variabilities.

3 Risk Factor Variabilities to Know 

There’s a lot that goes into understanding the full picture of a vendor’s financial health and what it is. A major component of vendor due diligence is obtaining various financial documentation, and having it assessed by a CPA or qualified expert to get a comprehensive understanding of a third-party's financial viability.

The documentation will provide insight around some additional risk factors like the following: 

1. Credit Risk. This is the probability that a vendor will be unable to repay debt obligations or meet contractual obligations.

Review the following to assess this:

• Credit history
• Capacity to repay
• Overall capital / access to financing
• Loan conditions
• Collateral requirements

2. Liquidity Risk. When an organization cannot generate cash flow or financing to meet any of its obligations without suffering catastrophic loss.

Review the following to assess this:

• Current assets
• Current liabilities
• Debt facilities / obligations
• Available cash / cash flow

3. Operational Risk. Decisions or behaviors relating to how the organization functions and what it prioritizes. For example, if an organization makes the decision to retain poorly functioning staff in order to maintain lower salary costs, this would be considered an operational risk.

How to assess:  You will need to work closely with your vendor in order to understand their critical objectives and processes before performing an independent validation of assessment which will ultimately roll up into your inherent and residual risk evaluations.

While this is by no means an exhaustive list of all of the many facets that make up financial risk, these key factors can help you build a better understanding around your vendor’s financial health, and ultimately, how it can impact your own. 

Is your vendor's financial health declining? Find out what you need to know. Download the infographic.