How to protect your business from supplier distress

Glenn Crisp, Jirsch Sutherland’s Managing Partner, Melbourne
Glenn Crisp, Jirsch Sutherland’s Managing Partner, Melbourne

COVID-19 has turned the way many organisations operate on their head. In a very short time, they have had to make the type of changes that usually take months if not years of planning. But while a business may be satisfied it’s done all it can to carry on operating effectively, what about its suppliers? If a major supplier falls over, this could have dire consequences on the business’s financial health.

Jirsch Sutherland’s Managing Partner – Victoria, Glenn Crisp, says every business owner and director should make sure they’re on top of their major suppliers’ financial health during this current crisis.

“The effects of COVID-19 have shown that most businesses – including large – are anything but prepared for such an event,” he says. “For example, the supply chain of major retailers was interrupted following the inability to source products from overseas, COVID-19 outbreaks at distribution centres and high demand for certain products have meant that many retail outlets have experienced problems stocking their shelves.”

Crisp says directors should be thinking about how they would cope if they lost their biggest suppliers. “Just because your business is fine doesn’t mean the business of your supplier is,” he says. “And if you need to change suppliers because one of yours fails, you’ll likely incur many costs while on-boarding a new one, including the cost of lost revenue.”

There are some typical warning signs to look out for that indicate a supplier may be in trouble, such as:

  • issues with fulfilling your orders
  • high staff turnover or a reduction in staff
  • poor record-keeping and a reluctance or inability to share financial information

Even if you’re satisfied your supplier is fine, it’s important to have a contingency or disaster recovery plan just in case. “Small businesses can suffer devastating consequences if a supplier falls over,” Crisp says. “That’s why it’s important to have plans in place that prepare for this eventuality.”

Conduct an audit of all critical suppliers

The first action a business should undertake is an audit of its suppliers to ascertain their strength and ability to withstand a crisis.

“It’s important, as part of a business continuity plan, to ascertain the ability of suppliers to meet their obligations to you,” Crisp says. “This includes any part of your business that you may have outsourced such as web-hosting or professional services. You need to consider the worst-case scenario and check how resilient your suppliers are with regards to security and reliability. Will they be able to continue to provide you with the services and products you require if they run into trouble? Find out what their disaster recovery plans entail and whether they have systems in place to deal with any continuity issues.”

Going straight to the source – your supplier’s financial statements – is another way you can get a sense of their financial health. “Your suppliers should be happy to share their statements with you,” Crisp says. “If they don’t want to, that could flag there are problems they’re hiding that they don’t wish to share.”

Check safeguards for those working from home

Crisp adds another issue concerns the increase in number of employees working from home. “Because of this trend, it’s important to know what safeguards have been put in place to protect your data and systems,” he says. “Make sure you are comfortable with any exposure and that your supplier is regularly carrying out risk assessments of their processes.”

He adds these types of evaluation processes should be carried out regularly anyway but never more so than during this pandemic.

“One addition to a contract you could consider is having the right to terminate a relationship if a supplier gets into difficulty,” Crisp says. “If your supplier can’t deliver and you’re locked into a contract that says you need to give a lengthy notice before you stop using them, then your business could suffer in the interim. Therefore, make sure you’re protected in your contract against any failure by a supplier to fulfil orders or from any issue that you feel may you may need to minimise your risk of doing business.”

Consider a back-up supplier

If you’re concerned that your usual supplier may experience future issues, it may make sense to form a relationship with another one. “You may have a great relationship with your current supplier but unexpected events like the one we’re experiencing now can create issues for any type of business,” Crisp says. “Having a back-up supplier is a sensible move in the event your main supplier falls over.”

What happens if your client goes bust?

Businesses may exist to serve their clients but if a major client falls over or becomes insolvent where does it leave that business? If they are owed a large amount of money, it could mean a devastating blow to their bottom line.

“If you find a client has entered into some form of insolvency administration owing you money, it may be possible to recover the debt, although it’s not easy,” Crisp says. “If you are listed as a creditor, the administrator will notify you and let you know if you are likely to receive any funds from the liquidation of your client’s assets.”

To do this, Crisp says, you need to lodge a proof of debt with the external administrator that details what you are owed and what the circumstances are. “Whether you get any money back will depend on the number of creditors and whether the client is likely to have any tangible assets that can be liquidated,” he says. “If the client is small, it’s probably unlikely there will be any assets that will be available to unsecured creditors.”

How to guard against taking on bad debtors

Because of the difficulty in getting payments from an insolvent client, it’s always preferable to try and avoid dealing with clients who can turn into bad debts. Crisp says carefully vetting a new client before you take them on makes sense, especially if they are likely to become a large customer. It is also a good idea to obtain personal guarantees where possible and even security over the debtor company or assets.

“Vetting involves carrying out credit checks and requesting references to see their business history,” he says. “These actions help ascertain the likelihood of their turning into bad debtors.”

He adds having very clear terms of trade is also important. “Make sure your client knows what these are, especially when payment is due and the action you’ll take if payment is not received. Of course, you don’t want to appear too aggressive with a new client, especially if it’s one that you’re hoping will turn into a fruitful relationship, but you do need to protect your business from the outset.”

If after vetting a client you still have concerns but want to go ahead and form a business relationship with them, you could request upfront payments or a deposit for the goods and services you’re providing, Crisp says.

“If clients are hesitant about this approach, you could offer them a discount for early payment,” he says. “But keep an eye out for them changing their payment behaviour – this goes for long-term clients too. If they start taking longer than usual to pay, this could be a red flag that indicates they are having financial troubles and you want to get on top of that straight away.”

Jirsch Sutherland