Rapid Ratings Blog

The 3 Myths of Private Company Financial Analysis: Lessons Learned from the Coates Engineering Group Bankruptcy

Posted by Rapid Ratings on October 21, 2016

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The time to get serious about supplier risk management is now, and most organizations know it.  Supplier disruption has shifted the tide towards proactive risk management in hopes of mitigating risks before it's too late. 

One of the biggest disruptions to any supply chain is the bankruptcy of a critical supplier. As we saw this summer with General Motors’ critical supplier, Clark-Cutler-McDermott, the ripple effect of supplier bankruptcy runs broad and deep. However, if businesses don’t fail overnight, then why are so many companies still struggling to better understand the financial health profiles of their critical suppliers?

Evaluating Public and Private Suppliers with Consistency

In part, companies struggle because many people assume public and private companies cannot be evaluated on similar terms and at similar depth.  This misconception stems from the assumption that, because their financials are widely available, public companies are vetted by the “market” and financial weaknesses will be flagged.  Also, people assume that they can review a public company’s financials whenever they need to.  These factors often lead to a false sense of security and insufficient analysis of the longer term viability of a supplier and its suitability over the long term supplier.

Importance of Gauging Financial Health of Private Suppliers

For most businesses, private companies will make up over 75% of their supply chains. However, they are largely underrepresented in supply chain risk management programs. While it’s acceptable for procurement to ask for private company financials during the onboarding process, later on when conducting the financial analysis of private suppliers on an ongoing or annual basis, category and other relationship managers will settle for much less, or even worse, skip right over private companies.

If such a large portion of supply chains are made up of private companies, and private companies can go bankrupt in the same way as public companies, then why are so many businesses shying away from evaluating their private suppliers with the same diligence as public suppliers?

Lessons from a Private Company Bankruptcy: Coates Engineering Group

Last month, a private U.K. company called Coates Engineering Group filed for bankruptcy, demonstrating why your private suppliers are just as important as your publics and deserve the same depth of analysis.

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Using publically available financials for Coates Engineering (many private companies in the U.K are required to file with Companies House, the U.K.’s company registry), our Financial Health Rating® (FHR) shows a clear downward trend from 2013 to 2015, falling from a 72, Low Risk, to a 32, High Risk, indicating a far greater probability of default.

Download the full FHR® and Financial Dialogue reports to better understand what happened to Coates Engineering.

While Rapid Ratings showed a clear and steady decline in Coates Engineering’s financial stability, organizations that rely on indicators like payment history were assured that the company had “low risk” of default. Although a quantitative FHR® clearly indicated that the company was becoming more vulnerable to bankruptcy, by relying on backwards-looking and incomplete data, Dun & Bradstreet (D&B) indicated Coates Engineering was a low-risk company the same month that it defaulted, leaving hardly any time to mitigate the risk.

Why didn’t D&B catch the inevitable default? A possible explanation is the “latency” issues with backward-looking indicators where a liquidity crisis at a supplier can happen very quickly, well before D&B shows a potential problem, or before the next quarter’s 10 k filing is issued by public companies.   

A public company that is at high risk of default holds the same potential as a private company to disrupt your supply chain and significantly impact your bottom line. This means that regardless of the extra effort required, you MUST hold private and public suppliers to the same standards and impose the same depth of analysis to successfully maintain a thorough and consistent risk management program. Being a private company isn’t something to hide behind anymore, especially if private companies make up a large portion of your portfolio. You need proper warning if any of your suppliers, public or private, are deteriorating financially, and you need full financial statements to get it.

The 3 Common Myths of Private Company Financial Analysis

  1. You can’t get financials from a private company.
    With a few exceptions (e.g. some countries in Europe require disclosure), private companies aren’t obligated to share their financials publicly. This makes it difficult to get financial statements, but not impossible. It’s still your responsibility to get financials because without them, you’re not doing financial analysis. Moreover, to ensure that you are consistently measuring financial risk across the board, you need to look at financial health through the same lens and with the same data for all companies, whether they’re public or private. You need to push your suppliers to get their financial data, or engage a firm like Rapid Ratings to push on your behalf.
  1. Using payment history constitutes financial analysis.
    Some risk managers will look at a company’s payment history to grasp its financial health with the idea that if a company can pay its bills, it’s financially viable. However, once a company fails to make payments, it’s too late. Most companies pay their bills promptly all the way into bankruptcy, giving you little to no time to mitigate the risk or seek alternatives. You need forward-looking tools, and actual financial analysis, to proactively manage risk.
  1. Some financial information is better than nothing.
    Since getting private company financial data can be a challenge, many risk managers will settle for less, accepting financials that are incomplete or a few years old. Using partial information can be misleading, though. Just because a private company was doing well a few years ago, doesn’t mean you can trust that the same is true today. To thoroughly mitigate risk, you need complete and ongoing transparency and nothing compares to using primary source financial statements from the company.

 

Topics: Supplier Risk Management, Bankruptcies & Default Studies