The novel COVID-19 pandemic upended many traditional business practices and forced companies to quickly address a multitude of disruption impacts. This primarily included employee and customer safety and alternative ways of doing business, but perhaps the foremost concern of many Chief Financial Officers (CFOs) and accounting/finance executives was addressing liquidity and cash flow needs. As such, companies typically have the option to pull cash out of their payables by extending the time to pay, and sometimes renegotiating terms with their vendors, so that cash is on hand as long as possible. This commonly used practice can offer companies interest-free financing for a short period of time. However, is there a hidden cost when this is completed too quickly or if unpaid invoices go beyond their due date? COVID-19 brought an opportunity for companies to work with their vendors, empathize with the unique situation resulting from the pandemic and understand the value of each link in the supply chain. As we look forward to a post-pandemic world, companies should be assessing their relationships with their valued vendors and ensuring they are leading with a long-term focus so that they are positioned to continue a strong symbiotic partnership.
Vendor Risk Assessment and Contract Due Diligence
Vendors are initially assigned an inherent risk rating, which should be refreshed at least annually:
If the vendor fails to meet expectations, it could result in a significant impact to operations and customers. The vendor would also be difficult to replace.
The vendor could impair the ability to execute on parts of the mission or financial stability and could be damaging to the company’s reputation, which would cause some disruption and can have high switchover costs to another vendor.
There is risk of a temporary decline on execution, mission or reputation with potential switchover costs and supply impact. There are other vendor relationships lined up to backfill if needed.
The vendor does not present a risk to execution, mission and reputation, and could be easily replaced.
The inherent risk rating of vendors is important as it could impact the performance of contract due diligence – the contract terms with the vendor should align with the company’s goals and risk appetite, and the terms should be favorable. There are several factors that should be evaluated regarding the vendor’s fit with the company, including specific risks associated with the vendor’s location (whether geo-political, logistical or legal), reputation, data privacy and finances. If the vendor has an inherent risk rating of either critical or high, there should also be sound business continuity plans ready and in place, should they require action. Scorecards for the vendor should also be established and monitored, with evaluation criteria based on service level agreements/obligations, due diligence, quality and timeliness expectations.
Leading Conversations with Honesty, Empathy, and a Partnership Mentality
At the onset of the pandemic, certain companies were able to capitalize on opportunities presented as a result of COVID-19, while others were, and in some cases still are, struggling. Thus, conversations with each supplier may look different depending on their individual facts and circumstances. The best way to navigate these conversations and build trust is to lead with honesty and transparency in order to develop an understanding that companies are dependent on each other. Consider asking and addressing how your company has had to adapt to these times, and how that has affected your long-term outlook. Answers to these questions can help you determine how your plans fit with the vendor’s so that both can weather the storm well.
Establishing trust through a partnership mentality can lay the groundwork for more particular details that mutually benefit each company. As the supplier and customer both attempt to maximize their cash flow, payment terms can be determined. Without talking to your suppliers, extending the time it takes to pay their invoices can damage the relationship and can also hurt their ability to maintain their operations.
Finally, it is important to continue analyzing key metrics for liquidity maintenance in payables and establishing certain benchmarks, sometimes categorized by company, where cash flow is being maximized, but not to the detriment of long-term relationships. Consider whether your payables turnover ratio is trending in the right direction, especially with your most important vendor relationships.
Here to Help
DHG is here to help you perform both supplier and customer effectiveness analyses and to help navigate communications with each. For more information, reach out to us at firstname.lastname@example.org.