Supply Chain Risk Management

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6

Financial Risk

If we listen to the “experts,” we might be tempted to believe that anything

that is not strategic to a business must be outsourced. Aer all, relying on

third- party specialists to support the noncore parts of your supply chain

is surely better than not relying on specialists. Specialists bring knowledge

and skills that are dicult to match internally, skills that should result in

lower costs and reduced risk. What could possibly be wrong with that logic?

at is probably what a U.S. manufacturer was thinking when it decided

to outsource its freight payments to a third- party payment vendor. Freight

payment is the process of applying a set of business rules and scal con-

trols around the authorization and payment of invoices for transportation

services.

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e proper use of a third- party expert should reduce a com-

pany’s risk as the freight vendor ensures accurate and timely payments are

made to carriers.

Unfortunately, the payment vendor in this saga began to experience

serious nancial problems that the manufacturer failed to recognize. As

the manufacturer forwarded consolidated payments to the freight vendor

for disbursement to transportation carriers, the payment vendor failed to

process those payments. Instead, the freight vendor used that money to

help meet its own cash ow obligations. It is not hard to imagine what

ensued once the nancial improprieties became known. Carriers became

angry due to a lack of payment, and the manufacturer entered what is best

described as a crisis state. Some carriers even started to send collections

people aer the manufacturing company! Condence was not restored

when representatives from the manufacturer visited the freight payment

vendor’s oce and found a For Sale sign in front of it.

Welcome to the world of nancial risk management, perhaps the most

thought about risk category since the nancial meltdown of 2008. is

chapter addresses nancial risk by rst discussing supplier nancial via-

bility and supply market volatility. e majority of this chapter presents

104 • Supply Chain Risk Management: An Emerging Discipline

approaches for addressing supply chain nancial risk, including assessing

supplier health using nancial ratios, bankruptcy predictors, and qualita-

tive risk indicators; assessing customer creditworthiness; nancial hedg-

ing; and approaches for managing currency risk. While assessment of

nancial risk is admittedly not the most exciting topic in the world, it is a

major part of the risk management process.

UNDERSTANDING FINANCIAL RISK

Virtually all supply chain risk events have nancial implications.

Everything that happens within a supply chain eventually ends up on the

income statement, balance sheet, or cash ow statement. Our interest in

this chapter is concerned with the kinds of events where the primary and

immediate eect is nancially related. In other words, nancial impact is

the primary rather than subsequent eect. Two major areas that comprise

nancial risk include supplier nancial viability and supply market vola-

tility, which the following discusses.

Supplier and Customer Financial Viability

Some observers will attribute the growth in the awareness of supply chain

risk management to the terrorist attacks on the United States in 2001.

However, even though these catastrophic events raised awareness about

U.S. vulnerabilities, it was not until the nancial meltdown of 2008 that

the shock came to the U.S. system, and even to the world, in terms of

supply chain risk awareness. At no point since the Great Depression did

the nancial system of the world’s largest economy risk collapsing to the

extent that we witnessed in 2008.

Extensive research and experience with companies has helped us reach

several conclusions regarding supplier and customer nancial risk analy-

sis. Financial risk analysis is about as far as most companies have pro-

gressed in terms of managing supply chain risk. Unfortunately, nancial

risk is not the only kind of risk present in supply chains. Second, given that

third- party data about suppliers and customers is increasingly available, it

should come as no surprise that most companies begin their supply chain

risk management journey looking at nancial risk of entities within the

supply chain. Keep in mind that assessing nancial strength is necessary