Using Financial Health Assessments to Reveal and Predict Supplier Risk
What is financial health?
Financial Health, at its core, is a pulse of a company’s well-being. Every decision a company makes - how they are engaging with their counterparties, managing their finances, funding their business, whether they are making investments or cost cuts, or burning through cash, is reflected in their financial statements.
Why is measuring Financial Health important?
Companies don’t fail overnight. Telltales are visible on their financial statements. A disciplined approach in assessing the financial health of your supplier provides you with advance warning into those telltales. It uncovers your suppliers’ strengths and weaknesses and provides insights into the actions your suppliers are undertaking to navigate through any opportunities or challenges. The outcome of the analysis helps you address any impending risks to your supply chain in a timely manner.
Companies continue to face internal and external pressures in doing business. Some of these are idiosyncratic and the outcome of their own choices, while others are market or macro driven.
The current economic environment with persistent inflation and high interest rates has aggravated the financial challenges for your suppliers. It has added to the costs of doing business and created additional strain on companies. Companies with good financial health can withstand price and capital fluctuations, manage regulatory requirements, and maintain standards. However, those with poor financial health lack the resilience to navigate these challenges. These companies spend more time fixing their financial woes at the cost of investments in quality, R&D, cyber, safety, and more.
Bankruptcies have also surged over the last few years. You continue to read about how companies are trying to strategically trim costs as a response to the current macroeconomic landscape, while others are struggling to stay afloat. Are your suppliers well positioned?
Per RapidRatings data, companies globally are seeing a decline in financial health. Average FHR has weakened from 62 (Low Risk) in 2021 to 59 (Medium Risk) in 2023. Moreover, the level of risk differs across various sectors. For eg, In the Computer Services sector, both public and private companies have deteriorated financial health between 2021 and 2023, but the private companies have deteriorated more rapidly than publics. Public companies deteriorate by 5% to FHR of 58 (Medium Risk) in 2023, while privates deteriorated by 8% to FHR of 56 (Medium Risk).
Financial health monitoring tools, such as RapidRatings’ FHR, give organizations a direct pulse on the risk of their suppliers. The FHR is not only an indicator of the default risk of a company, but a measure of the firm’s efficiency, competitiveness, and operational resilience. The risk insights enable meaningful discussions with suppliers about how they are navigating through challenges.
What is an example of financial health
Data-Driven Insights: Predicting Defaults
RapidRatings’ Annual Default Review showcases the undeniable link between financial health and default. A staggering 95% of companies that defaulted (rated High Risk or Very High Risk by FHR, score below 40) had exhibited financial weakness for three years prior. This data highlights the effectiveness of this approach for long-term risk prediction.
By prioritizing financial health analysis, risk managers can make informed risk assessment decisions based on the most accurate data on the market. This proactive approach safeguards your supply chain and prevents million-dollar blind spots.
Learn more about RapidRatings and SAP integrated financial health solution.
Discover the ways financial health reviews can help organization boost supply chain resilience.
