Verifying the financial performance of bidders

The use of the financial capacity of bidders as a suitability criterion is a frequently underestimated instrument for protecting against default or even default in performance resulting from economic problems on the part of the contractual partner. Particularly in the course of the current Corona crisis, the insolvency risk of many companies has increased, so that a review to this end is particularly useful, although it is also based to a large extent on long-term or long-term risks. strategic key figures and key figure systems presented in the first article, in order to exclude "prejudgements" based on 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 explore the question of how the economic performance of bidders can be determined transparently with the help of an examination 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 or. EBITDA beyond. As a liquidity-oriented parameter, cash flow, which has already been explained, is also only suitable to a limited extent for checking whether a company is z. B. insolvency could threaten in the near future or. How the company is doing in the long term. In addition, such operating earnings figures are only available to a limited extent in the case of small and medium-sized companies, or they are only available to a limited extent in the case of small and medium-sized companies. are rarely made transparent.

45 VgV provides that contracting authorities may, in particular, require the following for the purpose of verifying economic and financial standing:

  1. A specified minimum annual turnover, including a specified minimum annual turnover in the area of activity of the contract,
  2. Information on the candidates' or tenderers' balance sheets; the asset/liability ratio indicated in the balance sheets may be taken into account if the contracting authority uses transparent, objective and non-discriminatory methods and criteria for taking them into account and indicates the methods and criteria in the tender documents, or
  3. A professional or business liability insurance policy in a certain suitable amount.

As evidence of the required economic and financial capacity of the candidate or bidder, the contracting authority may, pursuant to § 45 para. 4 VgV (as a rule) require the submission of one or more of the following documents:

  1. Appropriate bank statements,
  2. Evidence of appropriate professional or public liability insurance,
  3. annual financial statements or extracts from annual financial statements, if their publication is required by law in the country in which the candidate or bidder is established,
  4. a statement of total turnover and, where appropriate, turnover in the field of activity of the contract; such a statement may be required for no more than the last three financial years and only if relevant information is available.

If – also in order not to impose unusually high requirements on the documents to be submitted vis-A-vis the bidders – one makes do with the tests mentioned in the procurement law or. documents, can be derived precisely from the annual financial statements or. the balance sheet and income statement contained therein, conclusions can be drawn about the bidder's creditworthiness with the aid of various key figures.

In this context, it is important to identify evidently unsuitable bidders, i.e. bidders who are economically too weak or. Identify underperforming bidders based on 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 provide an overall picture of the economic or. to maintain the bidder's financial performance.

Consideration of the balance sheet – how high 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. The bidder's financial position – as of a certain date.

Warning lights should come 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, this means that the company's reported liabilities do not include any non-cash assets or liabilities. assets in the corresponding amount. annual losses or a loss in the value of tangible assets u. a. In this case, the negative balance sheet items have resulted in the assets being worth less than the loans that the company has to repay. In order to compensate for this imbalance, so that the valuations of the funds tied up in the company and the source of funds are equal, the equity capital must assume a negative value. The company is literally over-indebted. As a rule, lenders will sooner or later question the creditworthiness of the company, as their loans are no longer covered.

A special case in this context are so-called equity-replacing loans, which generally represent loans from a shareholder to his company that, in the event of the company's insolvency, must by law be reclassified as equity or equity-replacing loans. are to be considered subordinate to the loans of other lenders. If such loans exist, they should be taken into account as a contribution made by shareholders when asking whether the company has sufficient equity capital, so as not to draw any false conclusions about the company's ability to survive.

How heavily indebted is the bidder?

Also of interest is the question of the company's debt/equity ratio. The debt-equity ratio is a balance sheet ratio that provides information on the structure of the company's financing. It illustrates the extent to which the company is dependent on debt or equity capital. equity-financed.

Debt/equity ratio: debt/equity x 100

z. B. 400.000 Euro / 200.000 euros x 100 = 200

A debt-equity ratio of 100% corresponds to a structure in which debt and equity are in balance; at a debt-equity ratio of 0%, the company would be fully equity-financed. If the debt-equity ratio is significantly above 100%, this means that the company's debts are a corresponding multiple of its own funds. Since depreciation and losses or. If net losses for the year are charged exclusively to equity, a company with a high debt-equity ratio runs a greater risk of having negative equity in the event of a number of bad financial years, or of having a negative equity ratio in the event of a number of bad financial years. 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 considering and interpreting individual variables or ratios separately. For this reason, it is advisable to collect several key figures and thus to check 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 (e.g., because the bidder does not collect these key figures due to its small size) are discussed in more detail below.

To assess the risk of insolvency, a basic evaluation and comparison of the following six metrics can be used. 1 These are first collected and then offset with factors to obtain an aggregated ratio on the basis of which a classification of the bidder's risk of insolvency becomes possible. The following explanations are particularly applicable to large companies, where these ratios are actually available or. can be easily requested or taken from annual reports.

In total, for a comprehensive assessment of the current insolvency risk, the following six variables must be determined or. must be requested 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 (EGT)

The following describes in detail how these figures are collected and which key figures can be formed with them. These key figures are then used to form an aggregated key figure, the classification of which provides information on how well a bidder is positioned economically and financially or how well a bidder is positioned financially. Whether it even has to be described as insolvency-prone.

1. Cash flow before taxes (CF) / liabilities
" How much cash flow per borrowed euro?"

This first ratio shows how high the proportion of liabilities is that can be repaid per year on the basis of the cash flow. It thus illustrates whether the company generates sufficient liquidity to service its own liabilities. If a company does not have any liabilities, this key figure (or. for the determination of 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 does not have any liabilities, the balance sheet total is used here.

3. inventories or. Current assets / operating performance
" How much current assets per euro turned over?"

The ratio shows the relationship between current assets and the company's own output. The operating performance is composed of sales revenue +/- any changes in inventories of semi-finished and finished goods or. work in progress (for manufacturing companies) + cash discount income + other ordinary income + own work capitalized. A high level of inventories has a negative impact on the profitability of the business and can be seen as an indicator that the company is not (or no longer) producing for the market, or that the company is not (or no longer) producing for the market. Too much current assets in relation to sales.

4. POA / total assets
"How much profit before tax per euro employed is?"

The result from ordinary activities includes EBIT (operating result before interest and taxes) and the financial result. The ratio thus shows the return on assets. So net income plus taxes paid is divided by total assets.

5. POA / operating performance
"How much pre-tax profit per euro turned over?"

Net income plus taxes paid is divided by operating performance (cf. also point 3) divided. The ratio shows the return on sales of the company and thus provides information on the ratio of profit to sales.

6. Operating performance / balance sheet total
"How much revenue per euro employed?"

Finally, the operating performance itself is also divided by the balance sheet total. The greater the proportion of sales to total assets, the less capital is required to achieve a given return on investment.

Aggregation of the key figures in a key figure system

The following table shows a system of key figures 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
Key figure Weighting factor Weighted key figure
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 return on capital 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 ..

Overall, on the basis of the various business performance indicators presented, or. On the basis of the weighted sum determined from this, it is possible to draw conclusions about the probability of insolvency of the company under consideration, which does justice to the claim that the economic performance indicators from the balance sheet and P&L should not be viewed in isolation from one another.

It should be noted, however, that the collected ratios can offset each other when compared in such a business ratio system, i.e. z. B. a (too) high level of debt can be compensated for by a good return on sales. In addition, it is clear that a very important indicator for the early detection of insolvency is the result from ordinary activities or. whose ratio to total available capital or the ratio of profit from ordinary activities to operating performance (i.e., mainly sales) is. In addition, the exact weighting of the individual factors is, strictly speaking, also sector-dependent. Thus z. B. a high level of debt in the real estate sector is not necessarily to be seen as problematic, which is why, depending on the sector, even slight corrections or. Adjustments to the above weightings are conceivable.

Interpretation of the key figures

The following table serves as a possible classification of the overall ratio calculated as described above:

Allocation table:

Total 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: poor
0,0 < Gesamtkennzahl ≤ 0,3: Slightly at risk of insolvency
-1,0 < Gesamtkennzahl ≤ 0,0: at risk of insolvency
Overall key figure < -1,0: High risk of insolvency

The higher the aggregated ratio, the lower the probability of insolvency can be considered to be. In this context, the above table provides an overview of the areas in which the aggregated ratio can be considered critical: In particular, for values below approx. 0.75, a closer look should be taken at whether the bidder is indeed still suitable. Here it is already worthwhile to examine in more detail the reason why the total value is relatively poor.

Values below 0.3 indicate critical problems for the bidder, which in case of doubt may lead to insolvency in the near future. As a rule, such low ratios only arise if cash flow or the result from ordinary activities are negative, but on the other hand there are no figures based on the substance of the company to compensate for this fact.

Of course, such test procedures can only be related to historical values, from which an early detection of acute insolvency risks can be derived. It goes without saying that 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, it would probably not be a reliable indicator of a bidder's suitability.

Alternative approaches in case of missing information

One problem with the method described in the previous section is that, particularly when assessing small and midsize companies, it is often the case that not all the variables needed to calculate the ratios are available.

The operating performance and cash flow, 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 an approximate solution in this case, instead of the operating performance, the turnover itself can be used, as shown in the P&L, without adjusting it for other ordinary income, own work capitalized, etc. to correct. If the cash flows as such are not explicitly stated, the result of a (z. B. The profitability of a company can be calculated either by using the net income statement (to be compiled by a sole trader) or by using the difference between sales and costs. Cash flow, which by definition is the difference between revenue and expenses, can thus often be substituted well, assuming that cash expenses can be approximated by (not necessarily immediately cash) costs.

Alternatively, it is possible to resort to a reduced key figure system. It is recommended that (at least) the following three cornerstones be examined in order to determine the economic creditworthiness or. Assess the risk of insolvency.

  • The bidder's indebtedness to check what proportion of the total funds available to him his liabilities take up in order to evaluate whether there is over-indebtedness.
  • The bidder's profitability to check whether he is able to generate profit and pay his liabilities from this (i.e. not by taking on new debt).
  • The bidder's return on sales to verify whether it is making a profit on the cash portion of its business model or whether other factors (such as z. B. to be taken with caution) are responsible for profit.

When comparing only a few key figures, 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 between 4 and 5 in order to be in the green zone, also due to the 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.

Total profitability is regularly considered to be above 6.x %. 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 studies, 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 insolvency cases, 2 which is why values in this range should be qualified as "bad".

Outlook over the series of contributions

Even though key figures and key performance indicator systems can provide a good basis for assessing the economic and financial suitability of bidders, depending on the tender, there are specifics to be taken into account for the individual key figures. In the next part of this series of articles, we will therefore deal with various special features as well as with the question of the admissibility under procurement law of checks on the economic and financial performance of bidders with a view to the relevant award practice of the awarding chambers.