Rapid Ratings Blog

Risk Management: Using Financial Health to Guide Your Way through Ambiguous Times

Posted by Rapid Ratings on November 22, 2016

Primary Sources Trump Market Sentiments

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With Donald Trump elected as the next President of the United States, many are asking what the corporate climate will look like in the coming year. How will the new administration affect trade, financial regulation, employment, corporate taxation, interest rates, or equity and credit market volatility? 

With greater uncertainty on the horizon, recognizing potential risks will become an even more critical part of doing business; mitigating them will be essential.

Three Ways that Market Inputs Can Skew Financial Risk Assessment

In volatile and unknown markets, it’s critical to reduce variables and to focus on what one can influence. Most imperative is choosing the right partners, suppliers, customers and other third parties to ensure business stability, resiliency, and minimize operational disruption, reputational risk and revenue risk.

Here are three example of how using market pricing data can compound volatility and obscure the positives and negatives of a company’s third parties.  

  1. Market volatility and uncertainty misguide your risk management decisions
    By nature, markets are volatile.  Markets reflect the general sentiment of investors, which can be heavily influenced by temperamental macro factors. Especially in this initial post-election time period, markets tend to be misleading. Trading can be impulsive, based on crowd reactions, and unreflective of company-specific fundamentals, particularly when party control changes. 

  2. Investor expectations don’t always parallel financial health
    The stock market is a great place for investors to evaluate companies to invest in and the likelihood for them to return a profit. Stock prices often reflect investor expectations for earnings, but not a company’s ability to operate and provide goods or services. Companies that are good to invest in and companies that are good to do business with are not always one in the same. Therefore, while a significant decline or increase in market prices is worth investigating, it should not be the primary tool for evaluating financial health. 

  3. Markets don’t provide a pulse on your private third parties
    When evaluating companies you do business with, it’s important to have a system in place that allows you to uniformly measure financial health, regardless of ownership, industry, or geography. Using market inputs excludes a large number of companies that are privately-held since they don’t have any market data.  Relying only on market pricing data leaves you without a pulse on a potentially significant portion of your portfolio. This makes it difficult or even impossible to draw well informed risk management comparisons and conclusions.

Financial Statements Provide Full Transparency into Financial Health

Within the context of enterprise risk management, no matter which risk area your company prioritizes, financial health acts as a common element that allows you to understand each company you’re working with on the same basis. Using a consistent and unbiased indicator allows you to be proactive during this “wait and see” period of time.

In times of market volatility, it’s imperative that we turn our attention to the facts – the data.  The most important indicators of financial risk (their ability to continue to operate, pay creditors, and provide goods and services) are the figures in their financial statements, reported directly by the company.  Financial statements do not take market volatility or investor sentiment into account, and allow you to maintain a consistent framework for all companies you do business with, including private companies. To learn more about private company financial analysis, read The 3 Myths of Private Company Financial Analysis.”

Financial statements provide full transparency into the company’s financial health and, when analyzed properly, are essential to mitigating risks and to maximizing relationships with the right companies.  Request a complimentary FHR Report to see what a thorough financial health evaluation should look like.

As 2017 approaches, most companies are in the process annual third-party reassessment. If the system and methodology used to evaluate financial risk relies on market sentiments (stock prices, option volatility, credit default spreads) they could be putting their revenue and reputation on the line.  Don’t let other signals of financial health distract you, make sure you understand the underlying facts and evaluate a company by its financials.

Topics: Supplier Risk Management, Third-Party Risk Management, Market Events