Guarding against supplier insolvency

Increased risk of insolvencies

Data from business intelligence company Red Flag Alert shows that despite emergency coronavirus measures such as the furlough scheme and government grants and loans, levels of insolvent business debt increased by 3.3% in 2020. With the government support ending soon and companies needing to start paying back coronavirus bank loans, we’re likely to see more insolvencies later in 2021. If one of these failing companies is a supplier, your company may find itself out of pocket for goods or services paid for in advance or you may see your supply chain cease abruptly.

Protection from supplier insolvency

There are several ways that you can protect your company against supplier insolvency .

Tip. Identify a backup that could be used in the event of your current supplier going under. Draw up contracts with the alternative supplier in advance so that the flow of goods and services can be maintained. Tip. Structure the ownership of goods so that these belong to your company as soon as production is finalised. This can ringfence them from assets being frozen during the insolvency process.

Mitigating the risk of supplier insolvency

Although you can put measures in place to protect your company from supplier insolvency, you should also be taking steps to mitigate the chances of your company being sucked in.

With the right data and insight, you can determine the financial health of the companies you are planning to buy from and opt for the supplier in the strongest financial position and least at risk of failure.

Analyse supplier cash flow. You should review the supplier’s balance sheet and carry out some simple liquidity analysis. Poor liquidity can lead to a constant need to plug holes in cash flow which is expensive, time consuming and often fatal for a business. This can also affect a supplier’s ability to fulfil their core service which may mean lower quality and poorer reliability, even before they become insolvent.

Tip. Calculate the current ratio (current assets/current liabilities). A ratio of less than one indicates that the company may have liquidity issues. Calculate the ratio over several years - a shrinking ratio is often an early warning sign of deteriorating financial performance that points towards insolvency.

Tip. Calculating the quick ratio (current assets less stock/current liabilities) can give a better indicator of liquidity than the current ratio if the supplier has high stock levels as stock isn’t always the most liquid of assets. Again, a ratio below one could indicate cash-flow issues.

Check the filing history at Companies House. Overdue accounts or a change in a filing period can be indicators that a company is in trouble. It may indicate that a supplier’s business is poorly managed. Overdue accounts can also delay obtaining a view on the financial health of a company.

Check your suppliers’ suppliers. Insolvencies can quickly ripple through supply chains so running credit checks on companies further down the supply chain can identify risks, which may appear to have several degrees of separation from your business but can pinpoint problems that may only be months away.