How can procurement departments manage the financial risks posed by their suppliers?

procurement departments financial risks
October 20th, 2020
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In the current economic climate, and even more so given the health crisis, managing supplier risks should be one of the main priorities for procurement departments. In this respect, it is important to note that financial risk is the supplier risk that is most destructive for companies, as opposed to risk related to brand reputation and compliance, for example. The good news is that Gartner has shared its best practices for better managing supplier financial risks by using its scorecard.

What do we mean by "financial risks"?

Financial risk refers to the financial viability of a given stakeholder, particularly whether they are currently in financial difficulty, or are likely to encounter financial difficulties in future, that would prevent them from fulfilling their obligations to their customers. Many factors can affect suppliers' financial health: market dynamics, competition, the economic climate or even a supplier's own operational or business model.

Companies often lack the reliable data and standardised process that would enable them to prepare for the financial risks posed by their suppliers. In such situations, a financial health scorecard can help procurement departments to gain clearer insight in this area.

Creating a financial health scorecard

Gartner has some advice on preparing a relevant scorecard and financial health rating to accurately compare suppliers. Above all, the process must be easy to implement and must be based on the selection and correlation of key financial criteria. Procurement departments will also benefit from storing historical data to identify trends and to have as much visibility into past situations as into current situations.

On a practical level, the advisory company recommends taking five criteria into account when creating a scorecard: revenue growth, profitability, cash flow, balance sheet strength and net debt.

To gather this information, companies mainly tend to use their own suppliers. However, there are also companies that specialise in this area, such as Thomson Reuters, Dun & Bradstreet and RapidRatings.

Procurement departments must then allocate points to each of these criteria and convert the total of these points into an overall rating. Gartner suggests a five-level rating system:

  • Strong: suppliers with sound financial performance and a viable and financially resilient business
  • Positive: suppliers with overall strength in financial performance
  • Variable: suppliers with inconsistent financial performance and possibly also with systemic issues
  • Caution: suppliers facing some financial performance challenges in one or more areas and most likely with systemic issues
  • Weak: suppliers with short- and long-term difficulties in creating resilient financial performance and with an indication of systemic issues

For further details on the criteria and rating system, see here.

Lastly, the final piece of advice is to take the specific characteristics of each supplier into account (their financial plan, their core business, their scope, whether they are a young company etc.) and to add qualitative comments that reflect the reality of the industry, the field and the supplier.

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