I’ll be the first to say that I spend little if any time pouring over a company’s financial data. We’ll save that for the Wall Street analysts. But from a supplier risk management perspective, the debt to capital ratio becomes a useful tool to determine the financial health of a company’s publicly traded suppliers. Now that may appear as a rather obvious “duh but let me put this analysis in context. Sure, it makes sense that this key ratio would provide some insight as to a company’s overall financial strength and even perhaps a company’s overall financial structure. But that ratio becomes even more important when considering some of the macroeconomic predictions for 2010.
Consider these notes taken from a recent economic forecast we attended presented by Alan Beaulieu & Brian Beaulieu of ITR (ITR claims to have a 96% accuracy rating looking four quarters out):
- 2010 mild recovery. Broad based U, no V and no W. No double dip
- Unemployment disconcerting. Much higher and longer than previously thought. Negative impact on consumer spending
- Bottlenecks in the supply chain pervasive
- Won’t be like 2008 for several years
- Next flat to recessionary years 2013 2014
- Must be profitable now
- Inflationary headwinds. M2 out of control
- US debt level horrible. By 2015 34.1% of GDP will go toward debt service that’s why we’ll inflate our way out of it (plus taxes on individuals and businesses)
We could probably write several posts on many of these points but we’ll focus in on just a couple bottlenecks in the supply chain and must be profitable now. My other half wrote a piece on Caterpillar’s strategy to reduce bottleneck risk where he cited the fact that Cat in some instances would provide prompt payment or financing to suppliers to secure parts and materials for Cat orders and thereby reduce potential bottlenecks. The second point the Beaulieu brothers make that companies must be profitable now relates to the fact that finding any new or additional credit from banks will remain a key challenge for all companies both private and public.
Now turning back to that debt to capital ratio defined as: Debt to capital ratio = Debt/Shareholder’s Equity + Debt. Reliance Steel and Aluminum reported a ratio of 28.3% back in November. Nucor recently reported a ratio of 28% (and along with it a comparison chart showing its “best in class financial leverage). You can check out your publicly traded suppliers yourself using the Altman Z Score. For privately held companies, the challenge becomes how does one gain access to this type of information? Perhaps a candid discussion of potential supply chain bottlenecks may help break the ice. Getting a handle on a company’s financial leverage could provide buying organizations with early warning signs and potential problems before they arise. At a very minimum, the debt to equity ratio analysis can provide another tool in the supply risk management toolkit.