Analyzing Vendor Financials During Economic Hardship

Analyzing your vendors’ financial health is a practice that can help mitigate many types of risk within your vendor base. However, financial health can be a little more challenging to assess during an economic downturn.

Suppose a vendor is showing signs of poor financial health, such as declining revenue, low cash balances, or recent news of a mass layoff. These signs may be more common during difficult economic times, but this does not make them any less important to analyze and scrutinize further. Your vendors’ financial health can have a significant impact on your organization. 

Let’s review some tips on how to assess this risk area more effectively during a challenging macroeconomic backdrop.

How Your Vendor’s Financial Health Can Impact Your Organization

Assessing and monitoring your vendors’ financial health is essential, as it helps identify various red flags that may lead to a domino effect in other areas of your organization. Consider the following ways your organization might be affected by a vendor’s poor financial health:

• Creates operational disruptions – A vendor that is struggling financially might be forced to downsize its staff or reduce spending in certain departments. As a result, this vendor is unable to meet its service level agreements (SLA) related to service uptime, which creates operational disruptions for your organization or customers.
• Misalignment with strategic goals – Vendors that have poor financial health may choose to cut back or discontinue products or services that do not contribute to their bottom line. This may be a concern for your organization if those divested or discontinued products and services from the vendor are essential to your operations or strategic goals. 
• Reputational damage – A vendor’s poor financial health can lead to staffing shortages and a decline in service quality, which is especially concerning if this vendor interacts with your customers on your behalf. Customers will see this poor service quality as a reflection of your organization, which can lead to lasting reputational damage. 
• Exposure to security risks – Investing in a robust cybersecurity and an internal information security program is essential, but may not be a priority for a vendor that is facing financial difficulties and needs to cut costs. Your organization and customers could be exposed to additional security risks if your vendor reduces spending in its cybersecurity oversight and program. 
• Financial hurdles – The domino effect of a vendor’s financial health can often lead to an impact on your own bottom line through increased costs that may also drive a decline in profitability for your organization. Consider the financial impact your organization can face, such as increased spending for operational disruptions, legal fees for third-party data breaches, and lost revenue from dissatisfied customers due to a vendor’s lack of performance against its contractual obligations to your organization.  

4 Tips to Assess Your Vendors During an Economic Downturn

A poor macroeconomic environment affects nearly every organization in one way or another. Some of your vendors may be struggling significantly, while others remain stable or even improve their financial health during a tough economic cycle. Financial health can fluctuate rapidly, so it’s important to understand some best practices for assessing your vendors during an economic downturn: 

• Prioritize your vendors – All vendors should be assessed for financial risk, but high-risk and critical vendors require the most scrutiny. These vendors will have more of an impact on your organization and customers, so they should be assessed and monitored more frequently. This allows you to identify and address any financial red flags before they become larger problems that are more difficult to resolve.
• Revisit vendor documentation – Depending on the size of your vendor inventory, you may discover that some vendor financial statements are missing or out of date. Refer to your organization’s due diligence requirements and make sure you have collected the appropriate financial documents. This generally includes two to three years of audited financial statements or annual reports, including a review of the vendor’s income statements, balance sheets, and cash flow statements.
• Identify and document red flags – When reviewing a vendor’s financial statements, a qualified subject matter expert (SME), such as a CPA or financial analyst, should identify and document any red flags that may indicate poor financial health. Red flags can be further discussed with the vendor to better understand the cause. This may reveal the extent of the current economy on the vendor’s financials, which gives you more insight to make better decisions about the relationship.  
• Look at the bigger picture – Regardless of the red flags you discover, it’s always important to take a holistic approach when assessing a vendor’s financial health. An economic downturn can give a distorted view on certain red flags such as a vendor’s declining revenue. If organizations are continuing to reduce their spending because of the poor economy, you may notice that this red flag is appearing more frequently in your vendor financial assessments. So, you may want to consider using other tools like financial benchmarks that can help give a bigger picture. Also, consider looking at data that isn’t found in a vendor’s financial statements, such as mergers and acquisitions, pending litigation, or a recent layoff.

An economic downturn can be unpredictable and often creates additional challenges in assessing a vendor’s financial health. By taking a strategic approach and focusing on your high-risk and critical vendors, your organization will be better prepared to mitigate financial risk, regardless of the current and future economic outlook.