SMEs: The financial KPIs you should use to assess your partners and customers

Financial analysis today can be complicated. Where once we looked at balance sheets to find receivables, debt, profit and loss, today we also consider EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization), cash conversion cycle and non-financial KPIs such as ESG – positive actions a company is expected to make in environmental, social, and governance matters.

In this article, we look at key KPIs to evaluate the financial health of your business partners. It takes more than numbers!

Basically, the reference KPI is EBITDA. It captures how the basic business is doing, without considering non-recurring items, erratic taxes, or debt loads.

In addition to EBITDA, look at:

• Revenue/sales: it should be positive. But in case of very fast growth, keep in mind that it must be funded.
• Net profit margin: the higher, the better.
• Leverage (Net debt / EBITDA): it should typically be below 3 or 4 but can also differ depending on the sector.
• Liquidity: it includes cash and non-withdrawn confirmed credit lines.
• Debt-to-equity ratios: it should be analyzed in the long term.

And don’t forget the Working Capital Requirement (WCR), a measure of the amount of liquidity that is trapped in the business at any time simply to maintain operations. It is calculated as the difference between short-term assets and short-term liabilities.    

In the longer term, look at equity, debt-to-equity ratios and debt maturity profile. How is their access to credit? 

Then, compare your findings to the industry average, and you have a picture of your partner’s financial viability. 

On a practical level, don’t be too rigid in how you judge the data. There’s no such thing as a “good” or “bad” ratio. For instance, a trading company usually operates with low margins and a high debt burden, leading to an elevated net debt-to-EBITDA ratio. However, this short-term debt is backed by inventories and buy/sell transactions. In the opposite, an industrial group will rely on long-term debt to maintain its machines and invest into heavy equipment.

All this is taking place against a background of unprecedented global turbulence created by the pandemic. The Covid-19 crisis has shown how interconnected our business activities are and how quickly problems can spread between partners and customers.

Financial monitoring of your own performance and that of your customers and partners will mitigate risks or distractions to your business. Dynamic monitoring is a necessary tool to identify weak links in your value chain. As Nicolas Marchenoir, Head of Commercial Underwriting at Allianz Trade France, says: “You can only be as good as your counterparties. If one or more has difficulty paying or supplying, so do you.” 

Let’s look at an example. Let’s say your main supplier is losing money. It might not just be due to the pandemic. He could be charging below-market prices himself. This means that if you have to replace him as a supplier, you will either end up buying more expensive materials from someone else, or compromise on quality to maintain your same level of expenditure. So you risk disrupting your supply chain or losing customers to the higher prices you may be forced to charge.

In order to be opportunistic, you first have to anticipate the worst-case scenarios. Forewarned is forearmed!

“A successful company is one that is in harmony with stakeholders such as customers, employees, suppliers and regulators,” points out Régis de Chambost, Regional Delegate at Allianz Trade France. Therefore, important indicators of a company’s character can include the rate of recommendation of the company by its customers or employees (Net Promoter Score or NPS), the rate of resignation, the rate of work accidents, the rate of absenteeism, the rate of customer retention, fines paid for failure to comply with regulations, the diversity of its employees, etc.

It helps to use a wide lens when assessing your partners and customers, especially as there are signs of economic rebound ahead, and you want to be sure that your value chain is nimble enough to take advantage of opportunities to come.

A risk expert who understands not just the numbers, but your business, your sector, and the economy can help you see this wider view and can create a sound basis for decisions. Trade credit insurance includes such risk expertise and helps you protect yourself against non-payment and look towards a prosperous future.