Supplier deterioration can be predicted as early as three years in advance. A new study by RapidRatings.com looked at financial records of
companies that filed for bankruptcy between 2014 and 2018 to determine the warning signs of poor financial health.
“Any supplier failure – whether due to a labour dispute, natural disaster, or credit default – can have financial, operational and reputational repercussions up and down the supply chain,” the study noted. “Transparency into both public and private company financial performance is therefore essential to supplier due diligence in both procurement and ongoing supplier risk management.”
The study found that financial deterioration in a supplier leads to pre-default problems such as declining product quality, inability to meet demand and on-time delivery failures. Companies that fall into the study’s High Risk category are twice as likely to deliver low quality or faulty goods, and nearly three times as likely to deliver late.
There are five warning signs that a supplier might be in trouble. These are:
High debt. Defaulters were found to have three times the debt and a higher cost to service it.
Poor cash flow. Failing companies had cash levels less than 15 percent of liabilities.
Declining profitability. Return on assets in defaulters declined from -17 percent to -33 percent between 2017 and 2018, the study found.
Climbing vulnerability to market forces. The energy and water sectors saw the great number of defaults in 2018 thanks to exposure to commodity pricing, politics, environmental concerns and changing regulations.
High risk factors. Using the study’s methodology, 95 percent failed while they were assessed as high or very high risk.
The study also points out that U.S. industrial defaults are at a five-year ebb, and the same condition applied before the last two recessions.
“With a potential recession looming and tariffs upending traditional trade flows, proactively monitoring the financial health of your supply
chain ecosystem enables you to identify early warning signs, build supply chain resilience, and avoid loss of revenue or reputational damage,” the study cautioned.