Supplier Financial Analysis For Procurement Professionals
Financial analysis can showcase the stability of a supplier, helping to drive better Procurement decisions and mitigate business risk. It also helps to avoid contracts with suppliers who might become bankrupt. This makes financial analysis an essential element of any Procurement professional’s tool kit.
But how do you conduct Supplier financial analysis?
What not to do while performing financial analysis:
Financial analysis is industry specific; so is only useful when you benchmark suppliers from the same industry against each other. The financial health of a supplier is dependent on how the industry is doing, so benchmarking suppliers across industries will be counterproductive.
Financial analysis formulas:
The table below provides all the important ratios with formula for conducting financial analysis.
Interpreting financial ratios:
Simply calculating financial ratios is not enough for financial analysis. It is also essential as a procurement professional to be able to interpret them.
- Profitability Ratios: These ratios help a procurement professional understand if the supplier can generate sustainable revenue and control costs. If any of the Profitability Ratios are considerably higher than other suppliers, the supplier in question either has great margins or is controlling cost tighter than peer suppliers.
- Gross Profit Margin: If the ratio percentage is greater than zero, the supplier can make a product/service profitably.
- Operating Profit Margin: This ratio provides information on a supplier’s business from an operational perspective. Negative Operating Profit Margin indicates that costs for the supplier are rising faster than the amount of revenue they can generate. If this trend continues, the supplier won’t be able to keep the business afloat for long.
- Net Profit Margin: This ratio helps gauge supplier’s capability to invest in new product development, research and Development, increase operating capacity, etc.
- Return on Assets: How efficiently a supplier uses its assets to generate earnings.
- Return on Equity: This ratio calculates percent profit your supplier makes for every dollar of invested shareholder equity.
To conclude, this post helps procurement professionals avoid some basic mistakes while performing financial analysis. Additionally, it provides formulas for conducting financial analysis and insights on how to interpret the results of Profitability Ratios.
Stay on the lookout for part two of this blog to learn how to interpret the rest of the financial ratios and some real-life examples.