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5 Steps to Evaluating Your Vendor’s Financial Stability

5 Steps to Evaluating Your Vendor’s Financial Stability

A company is only as good as its connections with other complementary enterprises. A vendor’s financial situation might not initially appear as something that impacts us. The truth is, it can indeed have a great impact on our organization. Our supply chain is directly affecting our ability to function as a company. If our vendor has any sort of trouble we will be stuck waiting for supplies and will be constantly wasting our time searching for new vendors. Uninterrupted service from our suppliers is paramount, especially if what they are delivering is vital to our business. It stands to reason that we need to be able to assess the risk associated with working with a particular supplier. It starts with evaluating their financial health as it is a good indicator of the overall wellbeing of the supplier’s business process. Here are some of the steps to take when looking into our supplier’s financials.

1. Supplier’s profitability ratio

Longevity is security when it comes to continuous business dealings. If a company is not profitable, it may not be in the business for a long time. This easily translates to our problem and we are stuck scrambling to find another supplier that is compatible with our expectations. We can assess a supplier’s profitability and margins. There are a few ratios that are relevant to us.on equity. Return on assets is calculated by dividing net income with their total assets. Return on equity is calculated by dividing net income with stockholder’s equity. Gross profit margin is (sales – cost of goods sold) divided by sales, the net profit margin is net income per sales. These metrics give us an understanding and best illustrate the financial state of our chosen supplier. We can extrapolate how the supplier in question is using its assets to generate profit, the rate of ROI (return on investment), any buffers they have to cover themselves and earning, all of which are indicators of sustainability. These are powerful tools that give us measurable, concrete data that we can quantify and use to our advantage.

2. The evaluation process

Using the tools gathered we can estimate the likelihood of a vendor remaining successful for about two or maybe more years. Here are some of the statistics and their trends that we need to look at. Last quarter’s profit, revenue, new license fees, service and maintenance fees, percentage of revenue spent on research and development, all twelve-month totals. More, the number of new deals, cash burn and generation rate, net debt and the next debt payment, employee yield and more. It may seem like a lot to go through, but it could save us a lot of pain and money in the long run.  If these metrics are above our paygrade, there are a lot of organizations that provide professional services like the Classic Funding Group. It is important to have this process done by someone who knows the field inside and out.

3. Communication

One of the key elements in any good cooperation is clear communication. Right from the get-go, if the supplier is available for questions, that is a good sign. This means if they are picking up the phone regularly when called and answering email quickly without using auto-reply bots. This is a great bedrock for a good customer-supplier relationship. The main contact within that company should be allocated and reserved for us. The reason for this is to reduce confusion as that person will always be in the loop on what is going on with regards to our wants and needs. That person also needs to be able to effectively communicate those wants and needs to their own teams accordingly. Ultimately, it comes down to us being able, should a problem arise which it inevitably will, to have the ability to speak with whoever is relevant in our supplier’s chain of command.

4. Making comparisons

If we are able to collect the financial ratios that we have went through, it is a great idea to benchmark or compare them to the industry averages. It will give us some orientation as to whether we are getting a good deal or not. The supplier can be under- or outperforming compared to the competition. This task might a bit complicated. Suppliers are usually privately-owned companies. Getting financial information for our own supplier might be difficult enough, let alone getting several others for comparison purposes. If we are unable to find relevant industry data for the private sector, we can use public company data from the relevant industry as a rough guide.

5. Asking the right questions

There is a set of questions that we can ask ourselves about our supplier to give us further insight into a potential collaboration. If our supplier is financially healthy, that is, are they making money and have enough capital to support their operations for the foreseeable future? What is their debt-to-worth ratio? It is not a standard metric but can help us greatly. What is their tangible net worth and can they continue operations at their current financial state? Comparing the answers to these questions with the calculated assumptions about the market and our future needs will give us the answer if this supplier is the right fit.

Suppliers are a great part of successful business operation and choosing one is no menial task. With these basic principles and a few simple equations, we can create tangible data on our best choice for the future.

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