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Assessing Vendor Financial Strength

Q: Should my vendor oversight program review the financial strength of my third-party vendors?

A: A financial review is a vital part of assessing the risk associated working with a third-party vendor – particularly if the vendor serves as a critical vendor for your company. Determining a vendor's financial strength helps evaluate whether that third-party vendor can meet its financial obligations as they become due and whether the vendor may encounter operational issues. The financial assessment should review financial highlights, as well as ratios and metrics that measure the vendor's fiscal performance. Ratios and metrics should provide information necessary to assess liquidity, profitability, operational performance, balance sheet management and the vendor's ability to manage cash flow.

Some characteristics to consider when assessing the financial strength of a vendor may include:

  • Working capital - Does the vendor have negative working capital? Is there enough liquidity or current assets to cover its current debt?
  • Net worth - Does the vendor have declining net worth? May it be depleted by annual operating losses, decrease in asset values relative to liabilities, or distributions/dividends paid?
  • Profitability - Does the vendor have net losses? Do expenses exceed revenue?

An effective vendor management program that assesses financial strength may help a company make an educated decision on whether or not to rely on and enter into a business relationship with a particular vendor, especially one that may be critical to your operations.

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