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Supplier Financial Management for Purchasing Professionals

Author(s):

Jeffery A. White, C.P.M.
Jeffery A. White, C.P.M., Manager, Procurement Compliance, United Defense L.P., Aiken, SC, 803/407-1398.

82nd Annual International Conference Proceedings - 1997 

The Issues. In today's dynamic business environment, purchasers experience supplier financial failures at an alarming rate. It is imperative that we are aware of potential financial distress before failure occurs. Additionally, we need to know what actions to take to minimize our companies risk in the event we are faced with the financial failure of a key supplier.

Successfully predicting supplier business failure through continuous monitoring is no longer a complex and tedious process. Every purchasing professional must be armed with the tools needed to implement a successful supplier financial management program.

The Opportunity. Statistics show that today, more so than other time in history, that a large percentage of our suppliers are experiencing financial distress. However, I challenge you to find an annual report from any of our top suppliers that paint an unfavorable financial outlook. Therefore, it should be no surprise that purchasers need to be keenly aware of their suppliers' financial health. Good supplier financial management is as important as just-in-time delivery, excellent quality, and a reasonable price. Furthermore, purchasers need real-world, hands-on, yet powerful tools that can quickly be used in pro-actively monitoring and analyzing a supplier's viability. The focus of effective supplier financial management is the evaluation of suppliers' primary and secondary financial data on a pro-active basis; before purchasers are faced with suppliers' financial distress. But, what tools are available for the purchasing professional to use in order to assess financial stability?

Objectives. We will discuss the factors important to launching a successful financial management program. Discussions will center around a financial model and tools that can be applied across industries, commodities, products and services.

We will be exposed to traditional as well as newly developed supplier financial assessment tools. These tools are combined in such a way as to provide for flexibility, power, and ease of use. Participants will be introduced to automated software and generic spreadsheets which serve as catalysts for efficiency in financial modeling. I will clearly and concisely demonstrate several financial assessment techniques that, if used properly, could assist purchasers in identifying financial distress in certain suppliers before they go out of business. In this way, purchases can begin to assist in controlling cost exposure.

I will also present a sample supplier financial assessment model and supplier financial management plan. This model is the focal point of a successful supplier financial assessment and management program.

Planning an Effective Supplier Financial Management Program. There are 3 key elements to an effective supplier financial management program:

  1. Develop a plan
  2. Documentation Requirements
  3. Measuring Results

The Plan. The first step in terms of establishment of an successful financial management program, is to establish a plan. The plan should began with a basic purpose statement. This statement will set the tone for your entire program, therefore, it may be the most important part of the document. In this section, your objective is to clearly and concisely disclose why you find it necessary to set up a program.

The next section of the plan should discuss the goals and objectives of your program. Think in terms of "who, what, when, where, and how" as you address this section. Answer issues such as:

  1. Who will be the suppliers included in this program? Supplier selection factors should include: New suppliers, single source suppliers, major dollar volume suppliers, top ten suppliers, suppliers with poor delivery, etc.
  2. What data will be collected? What will we do with the data? What if the supplier refuses to participate in the program? What is the plan of action if the supplier is not in good financial health?
  3. When (how frequently) will the data be collected?
  4. Where will the data transfer take place? (supplier's plant, via fax, e-mail, etc.)
  5. How will the results be documented?

The next section of the plan addresses the tools that will be used to assess each supplier. It is imperative that each supplier is measured equally. You should list in detail all software programs, spreadsheet models, primary and secondary reports required in order to perform each review.

Documentation Requirements. There are several important aspects of documentation. First, we must consider who is the ultimate internal "customer" for this product. The document should be written to address the relative management level of the customer. For example, a senior level executive with little time to spare, should be provided a report in a summary format, while a first level purchasing manager would be more appreciative of a detail report. I would strongly recommend your detailed report include a section that defines each tool used.

It is also very important to use charts and graphs within the report. Since the report's focus is on financial data, visuals quickly attracts the reader's attention. The graphs in this report usually consists of simple trend line graphs.

Measuring Results. The final aspect of an effective supplier financial management program is a process of measuring the success of the program. As with any management initiative, this program will cost your company money. Therefore, it is important to develop a means by which you can objectively determine the cost versus the benefits of this program.

The Financial Analysis Process. The heart of any company's supplier financial management program is the analysis phase. This phase starts with the collection of key financial data. For this phase, I recommend the use of a comprehensive Checksheet or questionnaire. The following is a detailed questionnaire that I use in my data collection efforts. Keep in mind that these are generic questions. All may not apply to each supplier you assess.

  1. What is business' fiscal year?
  2. Please provide the following corporate financial statements for last 3 years and current year interim (if applicable):
    • Profit and Loss Statement
    • Balance Statement
  3. Please provide copies of any cash flow forecasts developed for the last 3 years and current year interim.
  4. Please provide actual cash flow data for the last year, including reasonable and supporting assumptions.
  5. Provide an aging of accounts payables report for the last 2 years.
  6. Provide an aging of accounts receivable report for the last 2 years.
  7. Identify all outstanding loans. (including line of credits) Include the following:
    • Lending source
    • Amount of loan, Interest Rate, Origination date
    • Current balance
    • Monthly payments
    • Any special loan terms
  8. Has the company ever filed or have future plans to file for bankruptcy? If so, was it or will it be filed under Chapter 7 or Chapter 11?
  9. Has the company experienced any of the followings, if so please provide details:
    • Defaults on loan agreements
    • Denial of usual trade credit from suppliers
    • Contracts in a significant loss situation
    • Loss of principal customer/supplier
    • Uninsured or underinsured catastrophes
    • Labor strikes
    • Unpaid state, local, and Federal tax liabilities
    • Contingent liabilities
    • Deferral of payments to suppliers
    • Failure to fund pension plans
    • Loans from employees or issuing stock to employees in lieu of salary
    • Environmental clean-up impact
    • Significant unpaid company debts
    • Approval of unusual progress payments
    • Parent company undergoing financial distress/bankruptcy
  10. Provide a list of major customers and percentage of business.
  11. Provide access to previously paid invoices and canceled checks.
  12. Provide copy of last year's and next year's sales projections
  13. Are there any plans to sell or buy major resources
  14. Are there any plans to borrow money or restructure debt
  15. Are there any plans to reduce or delay expenditures
  16. Are there any plans to increase ownership equity

There are a number of sources of data that one can use to obtain answers to the above questions. Obviously requesting the information directly from the company is the best way to gather the facts required to perform your analysis. Additionally, many companies issue their financial reports on the Internet via news services. I use Search.com (www.search.com), News.com (www.news.com) CompuServe, and Reuters News Service on America On-Line as my primary Internet sources.

Additionally, several companies such as Dunn and Bradstreet collect and report financial data on millions of companies. For a fee, you can access their database and collect the much of the information you need.

Financial Statements to be Reviewed. The key financial statements used in our analysis are the Balance Sheet and Income Statement. Here are the definitions of each:

Balance Sheet: A listing of assets, liabilities, and stockholders equity grouped and presented in this order.

Income Statement: Often called a "Profit and Loss Statement", is a presentation of all revenues earned versus all expenses incurred during a specific period of time.

It is recommended that any financial records reviewed include a review of the previous 2 or 3 years of business activity along with the current year-to-date activities. The objective here is simple; look for a pattern or trend in the data over time. This will give you a broader prospective of a supplier's financial health.

Financial Assessment Model. The details, calculations, and methodology of the financial assessment model will be passed out to all workshop attendees.


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