What is Risk Mitigation?
Risk mitigation refers to the process of taking proactive actions to reduce the likelihood or impact of potential risks and uncertainties that could affect the success of a project, business, or individual endeavor. It is a fundamental component of risk management, which aims to identify, assess, and address risks to achieve better outcomes and protect against adverse events.
Risk mitigation is a popular procurement and strategic sourcing topic these days. One way to ensure a supplier’s ability to provide goods and services is to understand their financial health. Current ratio is a quick and straightforward way that works with even the most privately held companies.
What is Current Ratio?
The current ratio is gauged by an organizations ability to pay for its short-term liabilities or obligations with its short-term assets. It provides insight into the liquidity and short-term financial health of a business.
Current Ratio = Current Assets / Current Liabilities
- Current assets refer to assets that are expected to be converted into cash or used up within one year from the reporting date. Examples include cash, accounts receivable, inventory, and short-term investments.
- Current Liabilities refer to obligations or debts that an organization is required to settle within one year. This can include accounts payable, short-term loans, and other short-term liabilities.
To acquire a thorough insight of a company's financial health, the current ratio should be utilized in conjunction with other financial measures and research. Comparing an organization's current ratio over time or against its industry competitors can offer additional insight into its liquidity position and financial soundness. Additionally, different industries may have different typical current ratio ranges, so it's essential to consider industry norms while evaluating the ratio.
Reduce risk by integrating the current ratio into your RFPs and RFI’s
Reduce risk by reviewing an organization’s current ratio. The higher the current ratio the more likely a company can cover its obligations. A ratio of under 1 suggests that a company is at higher risk of bankruptcy. It does not mean they will be insolvent. There are many ways to raise capital. It does mean they are not financially healthy and are at a much higher risk of paying their own suppliers poorly, are at risk of bankruptcy, and are more likely to disrupt your supply chain.
The current ratio is particularly useful with public companies because they publish the information. Most sites where you can check stock quotes will show the current ratio. They have already done the work!
When speaking with privately owned companies it is an easier number to obtain. Especially when a strong business relationship does not exist, private companies may not share detailed financial information. However, asking them to supply the ratio gives insight as to how effectively they manage the business without asking them to reveal any actual sensitive figures such as revenue or profitability.
While the current ratio cannot replace a full financial audit, it can be an easy method to ensure a supplier is financially healthy. Add this question as is part of your strategic sourcing process. When conducting RFPs or RFI supplier health checks ask suppliers for their current ratio.