In the ever-changing realm of trade credit, where uncertainty looms and economic conditions can shift rapidly, conducting proper due diligence of vendors and customers through financial risk assessments (FRAs) has never been more important.
This is particularly true for suppliers to the hospitality industry. CreditorWatch’s monthly Business Risk Index shows that Food and Beverage Services is the highest ranked industry for the probability of payment defaults among all industries. This is primarily due to its reliance on discretionary spending, which is in sharp decline, as well as ongoing issues such as labour shortages.
To ensure unwavering confidence when entering into high-value contracts, the implementation of comprehensive financial risk assessments is essential.
What is a Financial Risk Assessment?
A Financial Risk Assessment is a comprehensive report that enables businesses to understand the financial viability of their customers, suppliers, and contractors. It helps assess whether your trading partners have the capacity to fulfill their financial obligations, such as making timely payments, ensuring uninterrupted supply of goods, and honouring contractual commitments.
By evaluating the reputation and financial stability of the entities you engage with, you can make more informed decisions when selecting trading partners, strengthening your ledger, increasing cash flow stability and allowing for better growth planning.
Why the extra level of protection?
As mentioned, payment defaults are highest for the food and beverage services sector than for any other. Defaults are a key indicator for business health as those with a payment default lodged against them by a single trading partner have a 24% chance of insolvency in the next 12 months.
Given these challenging trading conditions, it is crucial for businesses to have comprehensive and accurate information about their trading partners. This helps eliminate guesswork and enables more informed and confident decision-making.
How businesses can use FRAs to perform proper due diligence
- Client onboarding: When bringing new clients on board, conducting a Financial Risk Assessment helps gain insights into the prospective client’s financial stability and creditworthiness up front. This assessment guides the determination of appropriate credit terms, payment arrangements, and risk mitigation strategies before proceeding with the onboarding process.
- Due diligence: FRAs can play a central role in due diligence processes, particularly for businesses engaging in mergers, acquisitions or partnerships to expand their operations or diversify their portfolios. Before entering such transactions, it’s essential to properly assess the financial health of the target company.
- Vendor Analysis: By conducting FRAs on potential vendors, businesses can assess their financial viability and ability to fulfill contractual obligations.
What information should a Financial Risk Assessment provide?
A best-practice Financial Risk Assessment uses company financials, ASIC records, and trade payment data. An experienced analyst then evaluates all this information, to generate customisable reports on payment behaviour trends, ratios, and key financial performance indicators over a two to three-year period.
Additionally, you should receive a personalised interpretation of the company’s financial strengths and weaknesses, expert forecasting, and recommendations on implementing a specific risk management process to protect your business.
Key features that should be included in a Financial Risk Assessment:
- Organisation summary
- Financial risk rating
- Probability of default
- Financial performance summary
- Key financial performance indicators
- Financial trend graphs
- Key ratios
- Suitability assessment (credit limit or contract value)
- Professional opinion by a CA or CPA.
For more information on how Financial Risk Assessments can support your business, please visit creditorwatch.com.au