Financial Appraisal of Suppliers

How to conduct Financial Appraisal of Suppliers

When assessing financial risk it should be based on sound business judgement rather than just the application of financial ratios and formulas.

All bidders regardless of size should be treated fairly during the financial appraisal process.

You should request for bidders to provide accounts for the past 2 years of trading. Financial standing forms part of the risk assessment in the company’s suitability but does not reflect other risks about the supplier’s ability to deliver against your requirements.

2X minimum turnover is typically used as a useful indicator of financial stability but bidders should only fail this assessment if it’s clear that they have insufficient capacity to deliver the requirement.

When reviewing the P&L account and balance sheet check for sufficient cash flow and the ability to generate cash. If there are limited resources credit check reports provide a useful snapshot of the financial health of the providerFinancial checks is not an award criteria. Make sure checks are carried out in the suitability or pre- qualification stage.

Financial checks is not an award criteria. Make sure checks are carried out in the suitability or pre- qualification stage.

Conducting a detailed appraisal

Other factors to consider

  • Credit facilities
  • Debt ratings- Moody’s or Standard & Poor’s.
  • Merger/Acquisitions
  • Restructuring
  • Capital Investments

 

 

 

 

 

Warning signals for financial distress

  • cash draining from the business
  • falling profit margins
  • increasing overdraft with static turnover
  • major reductions in staffing
  • increasing employment with static turnover
  • increasing debtor and creditor days
  • larger increases in creditors than debtors
  • increasing stocks, slower stock turnover
  • deteriorating liquidity
  • over-reliance on short-term debt
  • high gearing
  • heavy write-offs of foreign or subsidiary holdings
  • late filing of accounts
  • qualified accounts
  • County Court Judgments (CCJs)
  • poor credit ratings
  • unusual accounting policies
  • changing auditors and bankers
  • debt rating downgrades/alerts
  • investment bank prospect reports
  • adverse press reports.

Cash flow

If possible check if additional information is available. Most companies operate internal management accounts for cash flow projections. This does not form part of their accounts but if such a forecast is made available it may provide useful information

 

Ratio analysis

The more detailed financial assessment should, where possible, include the calculation of a wider set of key accounting ratios so that the performance, efficiency and overall stability of the candidate can be quantitatively determined and compared with the previous year. The ratios should also be compared with the industry averages in the sector the supplier operates so that trends can be identified. However, ratios should not be considered solely at face value; all the other relevant factors referred to above must be taken into account.

Deed of Guarantee/Indemnity

Parent

A deed of guarantee can take the form of a performance guarantee, under which a third party, the guarantor, often the parent company, undertakes to fulfil the terms of the contract and/or a financial guarantee that ensures the Authority receives financial compensation if the contract is not fulfilled.

The contracting authority may need to obtain a deed of guarantee, particularly where a candidate’s financial position is less robust than that of its parent, or if the potential value of a strategic service award exceeds a supplier’s contract limit. The Authority should request a suitable guarantor and draw up the guarantee documentation following negotiations between the three parties and their legal representatives.

The deed of guarantee is not always sought from the parent company. A parent company guarantee is only as good as the financial standing of the parent itself. Sometimes, the parent is a mere ‘shell’ and another group or associate company, with the most assets, should be the guarantor. Although a guarantee can usually be obtained from a parent based in other member states of the EC, or in the USA, it is more difficult to obtain payment of a debt or to seek specific performance of the contract from a company not based in the UK.

Bank

A deed of guarantee can also be provided by a bank or insurance company. This can be a financial guarantee where the guarantor agrees to indemnify the Authority against losses, liabilities and expenses incurred if the supplier defaults on its contractual obligations. This may be less advantageous than a parent company guarantee if the guarantor is obliged to complete the contract.

There are a variety of alternative financial guarantees (bonds) that can be provided by the financial market. An advance payment bond, rarely used in Government, is an acceptable safeguard, particularly as the security is issued through a bank. The bond provider (supplier) usually bears the cost. Such instruments may be financially onerous on the candidate and are likely to be appropriate only in the absence of other credible guarantees.

 

Contract Management

As an essential ongoing activity after a major award, the Authority should continue to monitor the supplier’s financial and commercial standing, and whether it continues to have the necessary resources to manage the contract. The market in which it operates should also be reviewed. This will enable the Authority to recognise and respond quickly and appropriately to significant external events, pressures, or new information affecting the supplier’s viability or operations. Effort should, of course, be appropriate to the size and importance of the contract.