Verifying the financial standing of bidders
Using the financial capacity of bidders as a suitability criterion is a much underestimated tool to protect against default or even performance problems resulting from economic problems of the contractor. Particularly in the course of the current Corona crisis, the insolvency risk of many companies has increased, so that a review to this effect is particularly useful, but at the same time also to a large extent based on the long-term or financial performance of the bidder. strategic key figures and key figure systems should be carried out in order to exclude "pre-judgements" due to currently (operationally) poor key figures. After providing an overview of the conceptual basis in the first part of this series of articles, in this part we will look at how the economic performance of bidders can be determined transparently with the help of a consideration of various key figures.
As the first part of this series of articles has shown, the review of a bidder's financial performance goes beyond the mere consideration of variables or individual key figures such as net income or the EBIT presented in the first article or. EBITDA beyond. Cash flow, which has already been explained, is also a liquidity-oriented variable that is only of limited use in determining whether a company z. B. an imminent risk of insolvency may exist or. What the long-term future holds for the company. In addition, in the case of small and medium-sized enterprises, such operating result figures are only available to a limited extent or. are rarely made transparent.
Section 45 of the VgV provides that contracting authorities may, in particular, require the following for the purpose of verifying economic and financial standing:
- A certain minimum annual turnover, including a certain minimum annual turnover in the area of activity of the order,
- Information about candidates' or bidders' balance sheets; this may take into account the asset/liability ratio indicated in the balance sheets if the contracting authority uses transparent, objective, and nondiscriminatory methods and criteria for consideration and indicates the methods and criteria in the award documents; or
- a professional or business liability insurance in a certain suitable amount.
As evidence of the required economic and financial capacity of the candidate or tenderer, the contracting authority may, pursuant to Section 45 para. 4 VgV (as a rule) require the submission of one or more of the following documents:
- Corresponding bank statements,
- Evidence of appropriate professional or public liability insurance,
- Financial statements or extracts from financial statements, if their publication is required by law in the country in which the applicant or bidder is established,
- a statement of total turnover and, where applicable, turnover in the area of activity of the contract; such a statement can be requested for the last three financial years at most and only if corresponding data is available.
In order to avoid imposing unusually high requirements on bidders in terms of the documents they have to submit, the tests and criteria mentioned in the procurement law are used. Evidence, can be obtained precisely from the financial statements or. The balance sheet and income statement contained therein can be used to draw conclusions about the bidder's creditworthiness with the help of various key figures.
In this context, it is important to provide evidence of unsuitable, because economically too weak or. identify insufficiently economically capable bidders on the basis of certain characteristics, while at the same time taking care to consider the various metrics in relation to each other and not in isolation from each other, in order to obtain an overall picture of economic or. financial performance of the bidder.
Consideration of the balance sheet – What is the bidder's equity capital??
As already explained in the first part of this series of articles, the balance sheet is a comparison of assets – divided according to their use of funds (assets) and the source of funds (liabilities) of a company or. Bidder – to a specific deadline.
Warning lights should go on when looking at the balance sheet, especially if a bidder shows negative equity capital. Since both sides of the balance sheet – use of funds and source of funds – are always equal in size, this means that the company's reported liabilities do not include tangible assets or. assets in an equivalent amount. Annual shortfall or a loss in value of tangible assets u. a. in this case, have resulted in assets being worth less than the loans the company has to repay. To compensate for this imbalance, so that the valuations of the funds tied up in the company and the origin of the funds are equal, equity must assume a negative value. The company is over-indebted in the truest sense of the word. As a rule, lenders will sooner or later question the creditworthiness of the company, as their loans are no longer covered.
So-called equity-replacing loans are a special case in this context. As a rule, they represent loans from a shareholder to his company, which, in the event of the company's insolvency, must be reclassified as equity by operation of law or. are subordinate to the loans of the other debt capital providers. If such loans exist, they should be included in the question of whether the company has sufficient equity capital as a contribution made by shareholders in order to avoid drawing incorrect conclusions about the company's ability to survive.
How heavily is the bidder in debt?
Another interesting question is how the company's debt ratio is doing. The debt-equity ratio is a balance sheet ratio that provides information on the structure of the company's financing. It shows the extent to which the company is debt- or equity-financed. Is equity financed.
Debt/equity ratio: debt/equity x 100
z. B. 400.000 Euro / 200.000 Euro x 100 = 200
A debt-equity ratio of 100% corresponds to a structure in which debt and equity are in balance; with a debt-equity ratio of 0%, the company would be fully equity-financed. If the debt-to-equity ratio is well over 100%, this means that the company's debt is a corresponding multiple of its own funds. Since depreciation and losses resp. Annual net losses are charged solely to equity, a company with high leverage is more likely to run the risk of negative equity in the event of a few bad fiscal years or. to be overindebted.
Interaction of several key figures to check the economic and financial performance of a bidder against the background of an insolvency risk
As the previous comments in this series of articles have already made clear, there is a relatively high risk of erroneous conclusions when looking at and interpreting individual variables or key figures separately. For this reason, it is advisable to collect several key figures and thus to verify the economic and financial suitability of a bidder on the basis of the evaluation of several economic cornerstones. Cases in which such a holistic view is not possible due to a lack of information (for example, due to the fact that the bidder does not collect these ratios due to its small size) are discussed in more detail below.
In order to assess the risk of insolvency, an evaluation and comparison of the following six key figures can be used in principle. 1 These are first collected and then offset against factors to obtain an aggregated figure on the basis of which it is possible to classify the bidder's risk of insolvency. The following explanations are particularly applicable to large companies where these key figures are actually available or are not available. can be easily claimed or taken from business reports.
In total, for a comprehensive assessment of the current insolvency risk, the following six parameters must be determined or. are questioned by the bidder:
From the balance sheet (directly ascertainable): Current assets, liabilities, total assets
From the P&L (directly or indirectly ascertainable): Operating performance, cash flow before taxes, profit from ordinary activities (POA)
The following section describes in detail how these figures are collected and which ratios can be calculated using them. These ratios are then used to form an aggregated ratio, the classification of which provides information on how well a bidder is positioned economically and financially, or. Whether it must be called even insolvency endangered.
1. Cash flow before taxes (CF) / liabilities
"How much cash flow per euro borrowed"?"
This first ratio shows the proportion of liabilities that can be repaid per year based on the cash flow. It thus illustrates whether the company is generating enough liquidity to service its own liabilities. If a company has no liabilities, this ratio (or. to determine an aggregated key figure) the cash flow before taxes itself is used. If cash flow before taxes is not reported, it can also be determined as follows: Cash flow = net income + non-cash expenses – non-cash income.
2. Balance sheet total / liabilities
"How many euros of assets per euro borrowed?"
The ratio shows how high the share of liabilities is in relation to total capital, i.e. how strongly the company is financed by borrowed capital. In the event that the company has no liabilities, the balance sheet total is used here.
3. Supplies or. Current assets / operating revenue
"How much current assets per euro turned over?"
The ratio shows the relationship of current assets to operating assets. The operating performance is made up of sales revenue +/- any changes in inventories of semi-finished and finished goods or. work in progress (in the case of manufacturing companies) + cash discount income + other ordinary income + own work capitalized. A high inventory level has a negative impact on the profitability of the business and can be seen as an indicator that the company is not (any longer) producing for the market, or. Too much current assets available in relation to sales.
4. POA / balance sheet total
"How much profit before taxes per euro invested?"
Profit from ordinary activities includes EBIT (earnings before interest and taxes) and net financial result. The ratio thus shows the return on assets. So net income plus taxes paid is divided by total assets.
5. EGT / operating performance
"How much pre-tax profit per euro turned over?"
Net income plus taxes paid is determined by operating revenue (cf. also point 3) divided. The key figure illustrates the company's return on sales and thus provides information about the ratio of profit to sales.
6. Operating performance / Balance sheet total
"How much revenue per euro invested?"
Finally, the operating performance itself is also divided by the balance sheet total. The greater the percentage of sales to total assets, the less capital is required to achieve a given rate of return.
Aggregation of the key figures in a key figure system
The following table shows a key figure system in which the key figures described above are compared with each other and added together to form an overall key figure.
| Key figure no. | Key figure Addresses |
Key figure | Weighting factor | Weighted ratio |
| 1 | Liquidity | Cash flow / liabilities | x 1,5 | .. |
| 2 | Indebtedness resp. Financing | Balance sheet total / liabilities | x 0,08 | .. |
| 3 | Inventory intensity or. Capital commitment | Inventories (od.current assets)/operating performance | x -0,30 | .. |
| 4 | Total capital profitability | Profit from ordinary activities/total assets | x 10,00 | .. |
| 5 | Return on sales | Profit from ordinary activities/operating performance | x 5,00 | .. |
| 6 | Capital turnover | Operating performance / Balance sheet total | x 0,10 | .. |
| Sum |
All in all, on the basis of the various business performance indicators presented, or. the probability of insolvency of the company in question can be inferred on the basis of the weighted sum determined from this, which does justice to the claim that the economic performance indicators from the balance sheet and income statement should not be viewed in isolation from one another.
It should be noted, however, that the ratios collected can offset each other when compared in such a business ratio system, so z. B. a (too) high debt-equity ratio can be compensated by a good return on sales. In addition, it becomes clear that a very important indicator for the early detection of insolvency in the result from ordinary activities or. Its ratio to the total available capital respectively the ratio of the result of ordinary business activity to the operating performance (i.e. mainly the turnover) is. In addition, the exact weighting of the individual factors is, strictly speaking, also industry-dependent. Thus, z. B. a high indebtedness in the real estate industry is not to be seen necessarily as problematic, why in dependence on the industry also easy corrections and/or. Adjustments of the mentioned weightings are conceivable.
Interpretation of key figures
The following table serves as a possible classification of the overall indicator determined as described above:
Allocation table:
| Aggregate ratio > 3.0: | excellent |
| 2,2 < Gesamtkennzahl ≤ 3,0: | very good |
| 1,5 < Gesamtkennzahl ≤ 2,2: | good |
| 1,0 < Gesamtkennzahl ≤ 1,5: | medium |
| 0,3 < Gesamtkennzahl ≤ 1,0: | bad |
| 0,0 < Gesamtkennzahl ≤ 0,3: | slightly insolvent |
| -1,0 < Gesamtkennzahl ≤ 0,0: | at risk of insolvency |
| Overall key figure < -1,0: | at high risk of insolvency |
The higher the aggregate ratio, the lower the probability of insolvency can be considered. In this context, the above table provides an overview of the areas in which the aggregate ratio can be considered critical: In particular, for values below approx. 0.75, a closer look should be taken at whether the bidder is actually still suitable. Here it is already worthwhile to check in more detail what the cause is for the fact that the overall value turns out relatively poorly.
Values below 0.3 indicate critical problems for the bidder, which in case of doubt can lead to insolvency in the near future. As a rule, such low ratios only occur if cash flow or the result from ordinary activities are negative, but on the other hand, there are no variables related to the company's substance that compensate for this circumstance.
It goes without saying that such audits can only ever be based on historical values, from which an early detection of acute insolvency risks can be derived. Of course, it is not possible to anticipate future business developments, but in view of the principle of equal treatment and the objectivity required by contracting authorities, this would presumably not be a reliable indicator of the suitability of a bidder.
Alternative approaches to missing information
One problem with the procedure outlined in the previous section is that, particularly when assessing small and medium-sized companies, it is often the case that not all the variables needed to calculate the ratios are available.
Operating performance and cash flow in particular, i.e. the inflow of liquid funds into the company, are variables to which an awarding authority, in case of doubt, has no access or which are not even collected by the company or which are difficult to collect purely from a roughly structured balance sheet. As a rough approximation, in this case, instead of operating revenue, you can use the revenue itself as shown on the P&L, without adjusting it for other ordinary income, own work capitalized, etc. to be corrected. If the cash flows as such are not explicitly shown, an approximate solution can be the result of a (z. B. The signature can also be used to calculate the net income of a sole trader, or the difference between sales and costs. Cash flow, which by definition is the difference between revenue and expenses, can often be substituted well this way, assuming that cash expenses can be approximated by costs (which are not necessarily immediately cash expenses).
Alternatively, it is possible to use a reduced key indicator system. It is recommended that you look at (at least) the following three cornerstones to determine your economic creditworthiness or. assess the risk of insolvency.
- The bidder's indebtedness to verify what proportion of total funds available to it its liabilities take to evaluate whether it is overindebted.
- The bidder's profitability to check whether it is able to generate profit and pay its liabilities from this (i.e. not by taking on new debt).
- The bidder's return on sales to check whether he is making a profit on the cash part of his business model or whether other factors (such as z. B. to be taken with caution) are responsible for the profit.
When comparing only a few ratios, it can be useful to first assess and rank them individually and then compare the qualitative results: While in the case of debt, the ratio of total assets to liabilities may in any case be roughly between 4 and 5 in order to be in the green zone, also due to low interest rates, in the case of profitability and return on sales, it is necessary to consider them against the background of the respective sector.
As an overall profitability, more than 6.x% is regularly considered reasonable. In the case of return on sales, values of at least 5% are assumed, depending on the industry, although in some cases these can be significantly higher. According to research, the cash flow margin, i.e. the ratio of cash flow to sales, which should in principle be equivalent to the return on sales, was less than two percent in 71% of the insolvency cases, 2 which is why values in this range should be qualified as "poor.
Outlook on the series of contributions
Even though key figures and key figure systems can provide a good basis for checking the economic and financial suitability of bidders, there are special features to be taken into account for the individual key figures, depending on the invitation to bid. In the next part of this series of articles, we will therefore look at various special features and the question of the admissibility under procurement law of checks on the economic and financial performance of bidders, with a view to the relevant practice of the awarding chambers.
Footnotes
- The following is adapted from Lorenz, https://das-unternehmerhandbuch.en/insolvency-danger-a-quick-test/
- Cf. https://www.academy.en/knowledge/emergency-plan-avoidance-recovery-enterprise-crisis/key-figures