Sample of The Structure PDF

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Title:
The Importance of Financial Analysis in the Supplier
Selection Process
Program: MSc - FIN 7 - Grenoble (2012 - 2014)
Academic Year: 2013-2014
Dissertation / Project / Internship Report: Final Management Project 2013-2014
Student Name: Deligny Mickael Yoan Jonathan
School Tutor / Evaluator Name: Harrison Alison

Summary: The purpose of this paper is to understand the importance of financial evaluation
and the different techniques involved within the supplier selection process. Focusing mainly
on the Oil & Gas sector to understand and better establish the key intricacies of this industry.

Keywords: (cf. Thesaurus du Management):
ACCOUNTING - FINANCIAL STRUCTURE
ENERGY - OIL
CORPORATE FINANCE - CREDIT RISK
PRODUCTION MANAGEMENT - PURCHASING

(For access to the complementary Excel file, please contact me).

Non Confidential V Confidential

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REPORT STATUS: CONFIDENTIAL

Disclaimer

All the information and data represented in this
report with regards to Total S.A is the property of
Total S.A. Thus, it cannot be used or copied for
any intents and purposes other than the simple and
unique review of this report by the students
academic institution and the company dedicated
thesis supervisor.

Copyright by
Deligny Mickael Total S.A
2014

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Acknowledgements

First and foremost I want to thank my partner company: Total S.A and its Contract &
Procurement department. My greatest acknowledgments go to Steve Feuillerat and Katier
Bamba for all their help, patience and professionalism as well as their enduring assistance
during the course of this master thesis paper.

Having such a great partnership has really helped me accomplish my research and at the same
time develop a new topic of focus. Alongside this group I have had the privilege of
developing a study and a practical model which will be used within their department. This has
enabled me to truly push myself as a soon to be graduate. It has also allowed to leave a mark
at Total S.A meanwhile developing a new internal process which hopefully enhance their
daily operations. Additionally, without their help and access to quality data sources this
project would not present itself as it does now and for that I am extremely thankful.

Moreover, I would like to thank my tutor for the support and help received in making sure my
research was of the highest standard and assisting my progress along the entire process.

Finally, but not least importantly, my thanks go to my dear friend Ammad for his incredible
support, help, mutual advice which has been undeniably one of the key drivers in the
accomplishment of my FMP.

Ultimately, I would like to thank my family for their support during this long period of time
where their motivation and council has been invaluable. Teaching me about how to always
achieve my best possible and try the hardest in search for the best result.

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Abstract:

The purpose of this paper is to understand the importance of financial evaluation and the
different techniques involved within the supplier selection process. Focusing mainly on the
Oil & Gas sector to understand and better establish the key intricacies of this industry.

First we review the academic and business environment in order to observe how our partner
company (Total S.A) has developed the two key topics. This will allow us to better grasp the
complex business side of our research and suggest possible recommendations. Second, we
will construct a comprehensive table, acting as our key empirical tool for further
investigations. It will enable us to create a model, which scores and grades companies with
the goal of warning against potential supplier disruption events. Moreover, to complement the
study we will perform additional support tests to examine our different outputs and datasets.
Third and last, based on all our empirical and practical findings, we will develop a concrete
and easily applicable working process for our partners, using all the tools we have
implemented.
Moving on, the results of the research point out that financial evaluation technics play a
fundamental role in reducing supplier disruptions. However, they must be used with caution
taking into consideration all possible limits. We have found that a combination of different
methods and tools (tailored & standardized), established within a comprehensive process
created the best risk management and financial assessment situation. Meanwhile using our
dataset to create a scoring model, we have shown with a fairly strong accuracy that it was
possible to simply, yet powerfully caution against potential disruptive factors in the supplier
selection process.

Finally, the paper is of value and originality in two ways. First we have built an efficient,
operating and simple scoring model to implement with a quick working process for our
partners. Second and most significantly, we have identified the importance, limits and links
between financial evaluation technics and their respective roles within the supplier selection
process. Ultimately, paving the way for important further research in this field.

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Table of Contents
Chapter 1: Presentation ......................................................................................................................................... 10
Introduction ...................................................................................................................................................... 10
Research problem and questions ....................................................................................................................... 12
Significance of the study .................................................................................................................................. 13
Chapter 2: Academic and Literature Review ........................................................................................................ 15
I) Presentation of financial analysis and alternative evaluation methods ......................................................... 16
Financial Analysis ........................................................................................................................................ 16
Into the specifics of supplier financial viability assessment ......................................................................... 22
Beyond the basics ......................................................................................................................................... 24
Section Overview.............................................................................................................................................. 29
II) Supplier Selection Process ........................................................................................................................... 30
Introduction .................................................................................................................................................. 30
Supplier Selection Method ........................................................................................................................... 31
Supplier evaluation criteria........................................................................................................................... 34
Supplier Performance Evaluation Methods .................................................................................................. 36
SUPPLIER RISKS ....................................................................................................................................... 37
SRM / SCRM ............................................................................................................................................... 39
Specifics of the Oil & Gas Industry ............................................................................................................. 41
Supplier Selection Process conclusions & research ..................................................................................... 42
III) Conclusions of the Literature Review ........................................................................................................ 43
Chapter 3: Methodology ....................................................................................................................................... 44
A) Business Environment ................................................................................................................................. 46
Supplier selection ......................................................................................................................................... 46
Financial analysis ......................................................................................................................................... 47
Recommendations ........................................................................................................................................ 49
B) Approach & Methodology ........................................................................................................................... 51
Approach ...................................................................................................................................................... 51

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Methodology ................................................................................................................................................ 52
C) Conclusions ................................................................................................................................................. 63
Chapter 4: Results, Analysis & Discussions ......................................................................................................... 64
A) Master Table and its inputs....................................................................................................................... 64
B) The Outputs & Interpretation Keys .............................................................................................................. 65
C) Support tests ................................................................................................................................................ 67
Test A Master Table Review .................................................................................................................. 67
Test B Type Review Table ..................................................................................................................... 72
Test C Scoring Comparison Table .......................................................................................................... 74
D) Scenario Analysis ........................................................................................................................................ 75
E) Interview ...................................................................................................................................................... 78
Conclusions of the practical section ................................................................................................................. 79
Chapter 5: Conclusion and Recommendations ..................................................................................................... 80
Theoretical and Managerial implications .......................................................................................................... 80
1) Theoretical Implications ........................................................................................................................... 80
2) Managerial Implications........................................................................................................................... 82
Limitations / Further research ........................................................................................................................... 83
1) Theoretical limitations ............................................................................................................................. 83
2) Limitations of our methodology (general & practical) ............................................................................. 84
3) Suggestion for future research and application ........................................................................................ 85
Personal reflections and analysis of the work ................................................................................................... 86
Bibliography ......................................................................................................................................................... 87
Bibliography Financial Evaluation (Non-Cited Literature)................................................................................... 96
Bibliography Supplier Selection (Non-Cited Literature) ...................................................................................... 97

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Table of Appendices
Appendix (Academic Review) .............................................................................................................................. 98
Financial Evaluation ......................................................................................................................................... 98
Figure 1 (Ratio Detail Review Part 1) ....................................................................................................... 98
Figure 2 (Ratio Detail Review Part 2) ....................................................................................................... 99
Link 1 (Mertons DD model) ........................................................................................................................ 99
Link 2: (CHS Model) ................................................................................................................................... 99
Supplier Selection ........................................................................................................................................... 100
Figure 3 Supplier Selection Process Outlay ............................................................................................ 100
Figure 4 Selection Criteria Ranking ........................................................................................................ 100
Figure 5 Supplier Criteria for Performance Evaluation ........................................................................... 101
Figure 6- Supply chain risks and the related descriptions .......................................................................... 102
Extra Research 1 List of Supplier Selection Criteria ............................................................................... 103
Extra Research 2 Methodology Review .................................................................................................. 104
Extra Research 3 Supplier Selection and Assessment ............................................................................. 106
Extra Research 4 Vendor Selection, Processes & Practices ..................................................................... 107
Extra Research 5 Study on Supplier Risks .............................................................................................. 109
Appendix (Practical Section) .............................................................................................................................. 112
Summary of appendices .................................................................................................................................. 112
Exhibit A Financial Evaluation .................................................................................................................... 113
N1) Financial Evaluation Process - Step 1 ................................................................................................ 113

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N 9) Financial Evaluation Process - Step 9 ............................................................................................... 121
N10) Financial Evaluation Process - Step 10 ............................................................................................ 122
N 11) Financial Evaluation Process - Step 11 ........................................................................................... 123
N12) Brokers note sample Part 1 ........................................................................................................... 124
N 13) Brokers Note Part 2 ..................................................................................................................... 125
N14) Brokers Note Part 3 ...................................................................................................................... 125
N15) Total Financial Analysis Model Part 1 .......................................................................................... 127
Exhibit B Supplier Selection Process .......................................................................................................... 130
N1) Full Supplier Qualification Process ................................................................................................... 130
N2) Supplier registration form part 1 ..................................................................................................... 131
Exhibit C - Methodology ................................................................................................................................ 134
N1) Links which helped us for the Factor Selection in the reference table .............................................. 134
N2) Professional Interview ....................................................................................................................... 135
N3) Output Range / Benchmark Development ......................................................................................... 141
N4) Conversion table for support test C ................................................................................................... 143
Exhibit D Practical Section (Tables, Models, Tests and Scenario Analysis) ................................................ 144
N1) Screenshot sample - Master Table + Master Table Inputs .......................................................... 144
N2) Screenshot sample - Outputs & Multiple Regression Specifics......................................................... 146
N3) Screenshot sample - Support tests A (Graphs and Charts) ................................................................. 148
N4) Screenshot sample - Support test B Type Ranking Recap Table .................................................... 150
N5) Screenshot sample - Support test C Grading Table comparison ..................................................... 151
N6) Screenshot sample - Scenario Analysis + Supplier Alert News ......................................................... 152

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Chapter 1: Presentation

I ntroduction

Over the past 15 years or so, supplier bankruptcies and contract failures have cost tens of
million euros each year to major corporations
1
in the Oil & Gas industry.
These different fiascos are mostly the consequence of a lack of research, inefficient processes
and insufficient tools for analysis, regarding suppliers' financial health and general industry
conditions. However, the most shocking part is that a majority of these disruptive events could
have been prevented with better foresight and a clearer business methodology.
For many organizations, effective supplier evaluation and purchasing processes are of vital
importance. As the pace of market globalization quickens, the number of potential factors and
market elements to consider when selecting vendors has tremendously increased. Adding to
that, the recent shortcomings in many different areas all over the world has left professionals
wandering and reconsidering the risk profiles of many companies and partners. However, one
of the main challenges facing many supply management professionals is that of using
financial analysis information to evaluate suppliers financial health and their ability to honor
contract and operate soundly in the future. This is especially important because of the need to
exercise due diligence when selecting and monitoring sources.
In this paper we present the different academic foundings and theories regarding financial
evaluation and analysis, risk management, supplier qualification and selection processes. With
the objective of putting these academic fundamentals in perspective to contrast with concrete
instruments, practical tests and scenarios based on technical data collected in the field. These
findings will be presented under varied formats
2
making sure to answer the different research
questions of this paper and vastly cover the topic. Likewise, they will try to bring new details
to light and showcase the disparities between theory and practice within this field. This will
be crucial in implementing new solutions and showcasing some of the most apparent limits of
current academia, operations and processes, allowing room for further research.
The purpose of this paper is to attempt an assessment of this issue the importance of
financial analysis in supplier selection. To ascertain the usefulness of financial analysis in
this process, as well as elaborate the utility of other criteria present in supplier selection. It
will also try to moderate, bring criticism and suggest alternatives to implement, in order to
globally assess and hopefully improve the procedures.

1
Average based on top 500 major companies within the Oil & Gas sector from 2000-2010. Study performed by
Total C&P department at the end of 2010.
2
Tests, master table, scenario analysis, professional interview, statistical model and many other figures present in
appendices.

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The goal is to help professionals and academics to find common ground on what are the uses
and limits of standardized models, ratings, credit scores as well as other evaluation
techniques. With the objective of comparing them with tailored financial analysis as an
analytical method. This will allow us to see how efficient financial analysis or a combination
of methods can be at warning against disruptive
3
events and under what conditions. Giving a
new perspective on one of the most popular techniques in company evaluation, its recent
changes and how it can proficiently interact with other tools in a well thought out process.
With regards to this topic, academics have always been frugal towards the impact and
importance of financial analysis, often troubled with its confines. However, this strongly
contrasts with professionals in different industries using this technique as a key assessment
tool on a daily basis. This allowed us to observe a gap regarding: why a method so criticized
is being so regularly used? and at first glance it seems both parties could be right. Where,
ratio analysis showcases clear limitations, but in practice these shortcomings can be easily
overcome
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, as we observe the theory cannot account for all real life factors.
Moreover, some elements these past few years have become of major importance such as risk
management, rating grades and credit scores. They have been one of the most crucial growing
concerns with regards to all the worldwide instability and the increasing number of defaults
leaving the market at its peak in terms of precautionary attitude. These are also aspects we
will explore in our study in order to see what role these elements played in the past and what
role they hold today.
This can all be put in perspective when we look at the inevitable growing integration of
financial indicators within the industrial setting. Having a good supplier who does a good job
is not sufficient anymore. With the banks being more and more risk averse, handing out loans
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even to major companies and for huge projects has been on the downfall. Ultimately,
nowadays if the project risks
6
have not been reduced to their lowest
7
levels, we have
observed many delayed, incomplete or non-developed projects, due to a heavily strained
financial environment
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.

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Disruptive events cause problems to the normal functioning of the supply chain. Solvency and Liquidity (credit
default, poor cash flow setting, high receivables, etc.) issues are the most common type of factors triggering such
events. Finally, the extreme form of disruptions is obviously Bankruptcy and the shutting down of a company
and or all the steps beforehand (Chapter 11, Reorganisation process, Partial sale of assets, etc.).
4
Paired with other standardized tools and take into consideration situational factors when judging.
5
Loans here is in the wide term as companies have access to a much more varied type of financing then
individuals, such as credit lines or complex repayment scheme loans based on activity levels, etc.

6
Project risk: risks inherent to the project (operational, legal, financial, business, political, etc.).

7
Risk reduction can be achieved by third party risk management tools, internal risk mitigation processes and
various preventive warning measures.

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Where the different risks involved either come from a supplier delivery delay resulting in cost increases or a
vendor default putting in jeopardy the viability of an entire project operation they are part of.

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Research problem and questions
In summarization the supplier selection process is today one of the key activities in
organizations and with an uncertain economic environment the financial viability and
carefully assessment of suppliers has become a major interest. The Oil & Gas industry has
always had a strong contracts and procurement aspect due to the heavily supplier dependent
nature of the industry. Therefore, the research problem that this thesis attempts to answer has
been stated as follows:
How important is the financial evaluation of suppliers within the Oil & Gas industry and
what are the key considerations when trying to mitigate potential risks and disruption
factors?
In order to further clarify the scope of this thesis the research problem is digested into several
non-exhaustive research questions. It is important to determine the role played by financial
evaluation, understand the supplier selection process and analyze the different risks involved
to establish a basis for further developments.
These are the following major research questions we would like to explore, analyze and
answer throughout our final management project. We believe solving these interrogations will
best help us to follow a clear flow of ideas and help us best get across our conclusions.

What is financial evaluation and more precisely financial analysis (academic vs.
business standpoint) and what are the limits? How important a role does it play in
todays economy?
How can Financial Analysis help mitigate risks both financial and operational?
How can alternative methods of financial evaluation come into play and what are they
impacts vs. limits?
Could a combination of reviewed technics and instruments be implemented into a
well-developed methodology, in order to improve the efficiency of supplier financial
assessment?
What is the difference between the academic vs. business reality in financial
evaluation of suppliers? What does theory fail to grasp about procurement reality?
What are the most important tools at our disposal to carefully select suppliers? What
are the different obstacles in Supplier Selection and their impact?
Can thorough qualification standards help reduce supplier risk, if yes how?
How big a role risk management plays in financial analyses and the selection of
suppliers? How has this part evolved over the past decade?

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Significance of the study

Our study will attempt to answer a number of issues in procurement for the Oil & Gas
industry. Many changes have occurred resulting from massive recent economic disruptions
and other worldwide events which have impacted at different scales, the supply chains and
risk management environments. Special attention will be focused towards the role of financial
evaluation within the supplier selection process today and what it clearly involves.
We will observe how financial assessment can be considered one of the most important part of
risk management. Meanwhile, trying to assess the impact of todays turmoil on modern supply
chain management and how new or rethought financial processes can help mitigate the new
implied risks.
In order to make our study as relevant as possible, we have decided to partner up with a
reputable company (Total S.A) from our researched area. This industry was selected due to
its highly supplier oriented setting, risk concerns and subjectivity to different financial
disruptions. With this collaboration we are able to ensure the quality of our data, interviews,
information and knowledge gathered
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. Furthermore we have agreed on a set of different
objectives. The primary one being to develop in the form of a comprehensive excel file, a
technic and model to use as a warning tool against potential supplier disruptions and secondly
create a better overall working process.
Moving on, we have observed that our research environment is mostly populated by single-
topic oriented studies
10
not extensively covering the Oil & Gas industry. These subjects
develop fundamental concepts or singular empirical studies, but fail to explore cross reference
research to retrieve interactions between supplier selection and financial evaluation. Hence,
our paper will attempt to bring something new and grow on past literature to perform a
linking analysis between these different evaluation techniques and the supplier selection
process. We have for ambition to accomplish the initial paper on the matter and allow future
researchers to further advance on the broad study attempted here and lead to much more
sector focused papers
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.
The goal being to sensitize academics and professionals alike towards a neglected topic, with
an important function in todays corporate finance environment and evolving risk dynamic. In
turn, the project will contribute in the reduction of the knowledge gap where theorist and
practitioners fail to agree, enabling to find common ground for more efficient future
investigation.

9
Data was gathered from public sources and Totals private research, studies and investigations as well as
external sources they have access too.
10
What key ratios are most useful in financial analysis or evolution of supplier selection 1990-2010 and
even Alternative evaluation methods, what can they bring?.
11
The critical role of tailored financial analysis in the procurement setting of the automotive sector in Europe.

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Furthermore, both of our 2 key topics
12
explored here are often misunderstood by the different
parties involved. For example some supplier qualification experts and supply chain
professionals will not understand the true impacts of financial evaluation results, its
methodology and vice versa
13
. Meanwhile, we noticed that better results could be achieved if
more people were mindful on an industry wide basis of these key processes and standard
evaluation techniques. This is where our paper will attempt to make accessible the use of such
methods and develop a simple process using different developed tools to reach the widest
audience possible regarding financial risk assessment and what it involves.
Moving on, this work will allow us to develop and create a unique score, support tests,
sectorial data studies, interviews, scenario analysis and various outputs. All of which will
enable us to systematize and clarify a certain number of course of actions for our partner
company. To another extent, the goal will be to analyze this recouped information, establish
main conclusions and implement stronger working procedures using financial evaluation
within supplier selection. Meanwhile, allowing further exploration on the possibility of
preventing/foreseeing insolvency events in the future.
Additionally, our work intends to be an evaluating tool and guide book, showcasing the
efficiency of Total Exploration and Production C&P department methodology. To elaborate on
how their existing processes operate, review their analysis coverage and give feedback on
possible ameliorations to be implemented.
In a final dimension, our objective will be to analyze the value of alternative methods for
financial health evaluation as a warning instrument which would enable quick company
ratings and risk
14
profiling. These approaches, coupled with financial analysis will be
reviewed and tested
15
in order to capture the potential benefits and limitations of such new
associations
16
.
These practical investigations will enable us to test the strengths of standardized processes
17

but also their different limits. Hence, their potential need to be partnered with more tailored
analyses for detail and vigorous examinations of specific financial indicators
18
.

12
Supplier selection process and financial analysis.

13
Engineers grasp the technical aspect of a suppliers work but fail to maybe see some financial shortcomings,
hence provoking working tensions between analysts and technical people. This is turn, strains the decision
making processes in terms of reliability and efficiency.
14
Financial risks and operational to some extents.

15
In our practical section where we will perform many support tests on our gathered data and develop a model
to be implemented as the first part of a complete financial assessment process.
16
As this is not something literature has extensively reviewed if we look at past research papers.

17
D&B, Ratings, Credit scores, Statistical tools, etc.
18
(CF, FCF, equity changes, Change in ownership structure, Change in capital structure, etc.).

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To conclude, this complete approach will enable us to portray a clear vision (academic
findings vs. business reality) of how things operate, what needs to be modified and how? As
well as what will it bring to the sector in terms of conclusions?
Finally, it will lead to clearer processes
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, gains in time, newer resources and provide sounder
decision making rules, impacting risk levels on an industry wide basis. Ultimately, it is a
personal objective of mine to become knowledgeable in this field and provide professionals
with a clear framework, analyses and alternatives to what is available today.

Chapter 2: Academic and Literature Review

In order to successfully develop the key questions of our research on the importance of
financial analysis in supplier selection our goal is to grow on the key theories of each major
subject (financial analysis, alternative evaluation methods, risk management and the supplier
selection process). This, will allow us to get a general view but also enable to put in context
these foundations in relation to our research, based in a procurement setting within the Oil &
Gas sector.
Hence, for our academic review we will research and analyze the major and most cited
academic books, research papers/reviews and articles regarding these different topics in
order to get a general but detailed enough overview of each different theoretical foundations.
The literature review was improved by use of online computerized search engines and
databases including (ScienceDirect, ABIINFORM, INFOTRAC, ProQuest, JSTOR,
PsycINFO, etc.) using the different relevant keywords
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of our research. Furthermore, we will
try as much as possible to focus on newer research, despite accounting for the importance of
fundamental earlier studies within these areas of investigations.
Moreover, it is important to say that our study will for all intents and purposes focus on
evaluation mostly in a procurement setting. Where, we will always keep in mind the selection
of suppliers, despite equally talking about (FA) in a wider sense as an evaluation tool.
Additionally, we will bring a special focus to the Oil and Gas sector as often possible
21
to
make sure our reviews are accurate and in sync with our reviewed industry.
Finally, this will allow to situate our present research with previous studies, in order to most
appropriately lay-out the setting for our different tests and practical results within the second
section. Ultimately, helping reduce the knowledge gap existing between academics and
practitioners of this field.

19
Developed for our partner company. We intend this to be the initial work for further elaborations and detailed
evaluation processes within the department.
20
Financial analysis, Supplier selection, Financial assessment, Evaluation methods, Supply Management, etc.
21
Since very few to no academic literature exists on evaluation and financial health assessment within the Oil &
Gas sector.

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I ) Presentation of financial analysis and alternative evaluation methods

Many different approaches exist to analyze and evaluate the financial health, performance and
overall condition of a company and in our case suppliers in a procurement setting.
However, our objective is to perform a complete yet not exhaustive summary of the different
foundations and theories regarding financial evaluation. Finally, it will enable a fluid
navigation of the literature review grounding our research for the practical section ahead.

Financial Analysis

Financial analysis is an aspect of the overall business finance function that involves
examining historical data to gain information about the current and future financial health of a
company. It can be applied in a wide variety of situations to give business managers the
information they need to make critical decisions.

"The inability to understand and deal with financial data is a severe handicap in the
corporate world," - Donnahoe, 1989.

Financial statements are such accounts and reports, which contain the data required for
performance management. It is therefore important to analyze these records to identify the
strengths and weaknesses of different companies.
The performance of a firm can be assessed by computing strategic ratios and analyzing
different key factors using mainly a firms income statement, balance sheet and cash flow
statement (Gitman, 2009).
There are various methods available to evaluate the structure and activities of a company;
however some provide the better results according to (Platt & Platt, 1991). Where, ratio
analysis and multi discriminant analysis are some of them. As given by (Fridson & Alvarez,
2011) these types of analyses provided the learning on how effectively and naturally each of
the financial ratios could be used while assessing the financial health of companies.
Likewise, financial statement analysis is a useful measure to provide a snapshot of a firms
financial position (Muresan & Wolitzer, 2004) at any particular moment of time or to provide
a comprehensive idea about the financial performance of the company over a particular period
of time.
Furthermore, the use of financial ratios in finance must be multi-dimensional and the right
questions
22
need to be asked in order to accomplish a sound analysis and monitor a firms
sustainability carefully (Pandey, 2009).

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(a) How is the firm performing relative to the industry? (b) How is the firm performing relative to the leading
firms in their industry? (c) How does the current year performance compare to the previous year(s)? (d) What are
the variables driving the key ratios? (e) What are the links among the ratios? (f) What do the ratios reveal about
the future prospects of the firm for various stakeholders such as shareholders, bondholders, employees,
customers, etc.?

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This method is not only useful for judging of the financial health over time but also helps
identify and highlights the areas of poor performance and satisfactory performance, which can
help in identifying where the different strengths and weaknesses lay and where further effort
should be directed (Donnahoe, 1989). Ratio analysis is also a useful tool for comparison with
other firms positions in the same or different industries.
Moreover, the different financial statements of a business enterprise are intended to provide
much of the basic data used for decision making, and general evaluation of performance by
various groups
23.
The financial statements provide the key source of information for this type
of analysis (Casteuble, 1997); however these are not sufficient in providing detailed
information. Thus, external documents, project reports, sectorial analysis and other types of
resources need to be gathered and studied in order to provide added research material and help
get a complete picture of the situation.
Moving on, it is said that the main objective of ratio analysis is to use the results for decision-
making purposes. Thus, to facilitate this process, financial ratios have been widely classified
into various main sub categories according to their different purposes
24
such as liquidity
ratios, profitability, activity ratios, and solvency to name but only the major ones (Fridson &
Alvarez, 2011). Please refer to (Figure 1&2: Table of Useful ratios for financial ratio analysis)
for more information on each ratios.
Activity / efficiency ratios help measure the effectiveness of a firm's use of resources.
Where, (Nelgadde, 2010) mentions that a companys capacity to generate revenues in the
future will help evaluators judge of its financial viability. The benefits lie in the capacity to
compare the functional ability of the firm from different angles. Furthermore, activity ratios
also reduce the job of fixed asset management, which in turn helps the auditors to perform
audits faster and evaluators to see clearly (White, 2008).
Besides, (Clausen, 2009) states that the Profitability ratio analysis are used to measure
company profit performance (ability to generate earnings as compared to its expenses). These
indicators allow us to test the efficiency of a businesss activities and tell us a lot about its
operations (Zain, 2008). These ratios also force the evaluator to research some background
information regarding the nature/specifics of the business (i.e. seasonality factors).
On the other hand, Solvency ratios measure a companys aptitude to meet its longer-term
obligations (Thachappilly, 2009). The benefit of such ratios lie in the insight gained on a
companys capital structure as well as the level of financial leverage in place. Some ratios
allow investors to see whether a firm has adequate cash flows to consistently pay interest
payments and other fixed charges. If a company does not have enough cash flows, the firm is
most likely overburdened with debt and bondholders may force the company into default
(Hutchinson, 2010).

23
Such as: current owners, potential investors, creditors, government agencies, and in some instance,
competitors.

24
Other categories may not be represented here, if not relevant to our study: market ratios and investment
potential are 2 examples of non-cited types.

18

Finally the Liquidity ratios help identify good or bad short liability coverage and help
measure a firms ability to meet its short-term obligations (Clausen, 2009). A company must
have the capability to release cash from cash cycles to meet its financial obligations when the
creditors seek payment. The advantage of liquidity ratios is their quick ability to determine
whether a company will be able to continue as a going concern at least on the short term.
Thus, ratio analysis figure from the financial statements is a useful instrument used to
identify, quantify and value the company's financial position, efficiency, profitability and
strength both in a relative or absolute basis to other companies (Thachappilly, 2009).
Additionally, financial analysis does present a lot of benefits, especially for decision making
purposes (Helfert, 2002), as we know financial statements are made for providing raw
information only, not helpful for assessment. It is only when different ratios are computed that
it is possible to get useful information out of these records. For example if the calculated
interest coverage ratio is 10 times (up 25% from the past year) but the competitor company's
interest coverage ratio is 15 times. It means capacity of the profit of the other firm is higher.
This comparison will have helped the decision making process (Revsine, et al., 2004) to
increase the profitability, which at first sight might not have been an issue.
Still, ratios are useful in a certain extent to make trends, where useful information for future
forecasting and planning can be extracted (Brigham & Houston, 2011). For example, if we
observe a continuous decreasing trend over a five year collection period, we deduce that the
company is reducing the days for collection money to its debtors. With this information, we
are able to analyze the options available to the firm, its financial position and future options.
Financial analysis is a powerful tool to study the different correlation within firms operations
(Chabotar, 1989).
Accounting ratios dictate irregularities, surprises and anomalies which needs further
investigation to ascertain the future or current position of a company (Elliott & Elliott, 2010).
Additionally, ratios are very useful communication tools, as they reflect the companys
position, financial health and its future capacities. If we suppose, a companys gross profit
was 20% in (2010) and 29% in (2014), just by expressing this ratio, interested parties can
understand whether the company is growing or falling.
On top of that, ratio development can create co-ordination between the strengths and
weaknesses within companies to better judge the overall setting (Whittington, 1980). In return,
helping to identify potential viable suppliers and assess how the good and the bad interact
with each other for future purposes (Miller, 1972).
In addition, ratio analysis can also be used for controlling a business (Al-Ajmi, 2008) and in
our procurement research setting, the monitoring/qualifying of suppliers. It is easy to create
the standard of each financial item on the balance sheet and profit and loss account.
On this basis, can be calculated standard ratios of references. By comparing customary ratios
with actual accounting ratios, the variance can be extracted and analyzed. This variance may
be favorable or unfavorable and on this basis, allow monitoring the business from a financial
point of view.
As we have seen, financial analysis is a methodical evaluation of the profitability and strength
of different business concerns (Periasamy, 2013) and the key to its success is a clear structure
and process:

19

- First step is, assessing the interest and needs of different parties as their perspective
may be different and the context changing
25
. As suggested earlier, various users ap-
proach financial statement analysis with many different objectives (Khotari & Barone,
2010).
- Second step, it is important to understand what constitutes the different financial ratios,
where they come from
26
and which ones to select for the analysis?
- Third step is the external evaluation of the different influencing factors
27
and their po-
tential impact on the ratio analysis.
- Finally, a clear picture starts appearing when one looks at ratios over different time in-
crements and when comparison with results to the industry standards is developed.
Thus, leading to the use of different methods of financial assessment to get the most
objective conclusion possible (Wahlen, et al., 2010).
Elaborating on the previous final step, an analysis of financial statement for one year or
shorter would not truly reflect the nature of companys operations. For this, it is essential that
the study reasonably covers a longer period. The analysis made over a longer period is
characterized as Trend analysis or Horizontal analysis and indicates the direction of change
(Pandey, 2009). This method of analysis is simply comparing the same item in a company's
financial statements from two or more comparable periods and different timescales.
For example, when we hear someone saying that revenues increased by 10% this past quarter
or costs went down by 50 thousand euros representing a 5% decrease compared with last
years levels, that person is using horizontal analysis. It can be used on any item in a
company's financials (from revenues to earnings per share), and is useful when comparing the
performance of various companies and understand how different key factors have evolved
over the course of several years. In management accountancy, the calculation of trends is
based on the data of the past. This is favorable in deducing the current situation of the
company and the increase in the financial position of the company and growth over the past
years (Tracy, 2009).
Moreover, (Robertson & Mills, 1991) described another technique known as comparative
statement analysis to determine the viability of the data in respect to the associated variables.
It is used to relate the performance and position of firms with the average performance of the
industry or other specific target firms will allow portraying the differences in their financial
structure and operations. Therefore ratio analysis works as an indicator of the business which
allows the managers to track the trend and take the appropriate actions. Such comparisons will
help identify areas of weakness which can then be addressed to rectify the situation (Salmi, et
al., 1988).

25
Short-term creditors looking at liquidity profiles, long-terms creditors focusing on solvency capacities,
evaluation of supplier depending on length and size of contracts, comparative analysis, so and so forth.

26
Balance sheets represent a reflection for a particular point in time. Income statements present a cumulative
time summary of performance. For example, year-end financial statements should include a balance sheet that
presents how various company accounts look on that particular day at the end of the year, whereas the income
statement shows how companys performance is over the period.

27
Like management or owner decisions and discretionary spending, seasonal effects, legal structure choice, type
of industry, customer mix, or a number of other issues.

20

The third most common method is known as vertical or common-size analysis, which shows
each item on a statement as a percentage of a base figure within the statement. This type of
analysis illustrates the relationship of certain components compared to the whole, or the
financial stability of a company (Ross, et al., 1999). There are several different types of ratios
or indexes that may help us determine where the company currently stands in relationship to
where it wants to go. The most common form of vertical analysis is using percentages to show
one account's relationship to another. This way we can compare one company's results with
those of another, even though the size of the companies may vary significantly. If our
company is profiting 10 cents for every sales euro, and another company is getting only 4
cents it may indicate we're being more efficient. Another example is if the sales revenue of a
company is 10 million euros and the cost of sales is 6 million euros, the cost of sales will be
reported as 60% of the sales revenue or in the balance sheet when every item is represented as
a proportion of the total assets. Comparison of absolute amounts of companies of different
sizes does not provide useful conclusions about their financial performance and financial
position (Subramanyam & Wild, 2009). Usually the vertical analysis is performed for a single
accounting period to see the relative proportions of different account balances.
Nevertheless, it is also useful to implement over a number of periods, where it takes the name
of percentage analysis, in order to identify changes in accounts over time. It can help to
identify unusual changes in the behavior of accounts. For example, if the cost of sales has
been consistently 45% in the history, then a sudden new percentage of 60% should catch the
attention of analysts.
This type of analysis will also be very telling when compared to industry levels via
benchmarks, where the general position of the company on specific factors will be assessed
to get a general performance overview (Keown, et al., 2006). Finally the reasons behind the
changes (variations) and discrepancies to the point of reference can be investigated and
appropriate corrective measures taken.
Ultimately, these different approaches are rarely used as stand-alone and take most of their
meaning when combined together to analyze different aspects and key factors within the
firms financial setup (Wahlen, et al., 2010).
Another important concept within financial analysis and the decision making process is that of
materiality of information (Brennan & Gray, 2005). An item is considered material if
knowledge of it would influence the decision of a reasonably informed user. Thus, not all
information is worth analyzing and not all studies performed tell relevant stories, which is
important to keep in mind when displaying all these different processes.
Additionally, many academics have noticed that over the years, there has been a proliferation
in the number of financial ratios developed and applied by analysts and researchers. However,
it is impractical and sometimes improbable to compute all the ratios to reach to the desired
conclusion. Something called factor analysis was first applied to financial ratios by (Pinches,
et al., 1973) in an attempt to develop an empirically-based classification of financial ratios.
With the presence of inter-relationships within and among the sets of financial ratios, a
smaller number of representative ratios may be sufficient to capture most of the desired
information (Hamdi & Abdelrazzak, 1994). This inter-relationship is called multi-
colinearity in statistical language. Using statistical methods, this effect can be diminished by
finding out the factors (latent variables) inherent to the total set of financial ratios.

21

Finally, a recurring topic within ratio analysis concerns its different limits in efficiency and
coherence (Hey-Cunningham, 2002). For instances when looking at accounting policies
28
,
many small differences can have much bigger overall impacts on the view one can have of a
companys financial setting. If for example, the fiscal years are different, key information
29

are regrouped together but not dissociated and we observe that the resulted ratios cannot be
compared
30
anymore. Dissimilarity in accounting methods & policies has been one of the key
arguments against the overreliance on financial analysis; however their progressive
convergence (IFRS - US GAAP and exceptions aside) has enabled evaluations to be clearer
and easier to perform.
Furthermore, accounting principles are lenient at times, so the policies of a company can be
very important. Looking into a specific company's accounting policies can signal whether
management is conservative or aggressive when reporting earnings. Nevertheless, these
variations must be accounted for in terms of adjustments when performing comparisons to
avoid huge disparities, where none may lay.
Another possible issue comes from the fact that ratios are calculated using company financials
and can often times be wrong or massaged in several ways to make the figures used for
ratios more attractive, thus potentially modifying prediction from the analysis
31
. Sometimes
due to the bad financial position some companies publish their financial information
depending on their convenience (Eccles & Pyburn, 1992).
Also, changes in the information
32
underlying ratios can hamper comparisons as well as
fluctuation in the prices which sometimes make the calculations for ratios difficult. Another
issue is that of Immature Organizations, where a company (supplier) is relatively young or
has a short financial history. This in turn may limit their ability to deliver historical
information providing financial viability assurances, which showcases one of the biggest
drawbacks with traditional evaluation methods
33
(Revsine, et al., 2004).
Besides that, (Simpson, et al., 2007) noted that there are some limitations of financial ratios in
small and medium sized enterprise (SMEs). First, ratio analysis is meaningless if the company
generated loss, as for SMEs compared with large companies, losses is not an always a sign of
failure (small firms need to spend to develop and grow).

28
Accounting policies differ from accounting principles in that the principles are the rules and the policies are a
company's way of adhering to the rules.
29
Amortization, provisions and or different depreciation methodologies.
30
For example some companies follow FIFO process and some follow LIFO process for their inventory
management. Hence, ratios will show information that is not comparable at this level.

31
For example, many businesses delay payments to trade creditors at the end of the financial year to make the
cash balance higher than normal and the creditor days figure higher too.

32
Debt/capital structure change, IPO, acquisitions / sale, accounting standards or processes, production of goods
and value of assets.

33
Here academics tend to agree on the need for the different departments and agencies involved to consider
requesting further information to complement a rather meager financial health profile report: business plans;
bank statements for current liquidity; parent company or investor guarantee; and financial statements of parent
company or investor.

22

Another key limit concerns the availability of data regarding private companies. These firms
do not have the same reporting obligations as public companies, and thus their financial
situations are rarely transparent enough and can lead to many question marks during business
assessments. Moreover, when attempting to evaluate such companies and compare with
industry numbers, unless we have access to private data from the (companies themselves or
third party assessors); the benchmarks are non-existent since they are based on public data.
So, the issue is both of ease of data recuperation and data quality, as not being under the same
scrutiny as public groups, private entities tend to often have very dissimilar financial
statements, accounting and reporting policies leaving room for much interpretation
34
.
Likewise, ratio analysis provides the quantitative analysis of the company therefore the
qualitative analysis part is entirely ignored and must if needed be performed separately
35
.
Another issue lies in seasonal factors which can also distort ratio analysis (Brigham &
Houston, 2011). Understanding seasonal factors that affect a business can reduce the chance
of misinterpretation
36
. It is difficult to generalize about whether a ratio is good or not as
different situations warrant different interpretation
37
. Additionally, always making sure that
ratio calculations are the same as the industry average methodology is a challenge as many
techniques exist for calculating the same ratios (Robinson, et al., 2012).
Lastly, limits of ratio analysis are extremely important since they allow for further research to
complement the evaluation process. Not all but some of the limitations can be removed such
as accuracy in financial statements which can be cross checked with the project figures and
actual growth rate of the company.
Ultimately, if used alone there is a risk of portraying an overly simplistic view of the company
by distilling a great deal of information into a single number or series of numbers (Lee, et al.,
2009). This showcases the need for other approaches to be developed in parallel, to
complement this analysis and make the overall process as sound as possible, reducing the
different drawbacks.

Into the specifics of supplier financial viability assessment

An assessment of the financial stability and fiscal outlook of the supplier is a factor gaining in
importance in the growing trend of forging supplier-buyer partnerships. Both buyers and
sellers are looking for partners that are viable, ongoing concerns that will contribute to the
relationship both for the present and in the future. A supplier on financially unstable footing
will have much more difficulty contributing to the partnership venture, as it must focus its
efforts on improving its financial soundness (Ellram, 1990).

34
We will see later on, in the practical section how we have dealt with the data collection aspects of our thesis.
Also observe how private companies can successfully and safely be evaluated when disposing of ample
processes, risk management tools and sufficient data access.
35
Like we mention later on in qualitative analysis.

36
For example, a retailer's inventory may be high in the summer in preparation for the back-to-school season. As
a result, the company's accounts payable will be high and its ROA low.

37
A high cash ratio in a historically classified growth company may be interpreted as a good sign, but could also
be seen as a sign that the company is no longer a growth company and should command lower valuations.

23

Moreover financial viability can rapidly deteriorate or improve with changes to the economic
and operating environment (U.K Government, 2013). As such, it should be recognized that a
point in time financial evaluation cannot screen out all risky suppliers (Robertson & Mills,
1988), and is not a substitute for sound project planning and contract management and most
of all multi-dimensional analyses.
Whereas, the information provided for financial evaluations is a historical snapshot which can
only give current or short term future prospects based on current, known issues and situations.
The evaluator must be able to assess if the potential supplier it is dealing with is likely to
remain financially sustainable
38
for the life of the planned contract or can be readily replaced
should they become insolvent (Wright & Gallun, 2008). Usually, the larger the contract, the
more critical the purchase/partnership or the longer term the agreement, the more important it
becomes. Then, financial evaluation and performance analysis becomes a warning system to
the different parties and assists them across many different decision making processes such as
supplier selection and later on qualification (Karacaer & Kapusuzolu, 2008).
Furthermore, the paper Evaluating the Financial Condition of Suppliers by (Cancro &
McGinnis, 2004), provides an overview of the importance and challenges of monitoring
supplier financial health via different techniques and approaches (ratio and qualitative
analysis). The idea of interruption in a critical supply source, due a suppliers bankruptcy or
weak financial position, can be devastating to a firms ability to meet customer needs and
deteriorate its own operations. Thus, monitoring suppliers financial health can be delicate and
challenging because the signs of financial distress often materialize slowly and are often
concealed by the distressed firms. Another challenge arises as many suppliers are privately
owned, meaning that financial Information may not be publicly available. In some cases,
other suppliers may be divisions of larger firms
39
that disguise the results of individual
operating units in their overall financial reports, complicating investigations.

Another critical topic to understand is that standards, benchmarks and key financial ratios
vary widely by industry (Robertson & Mills, 1988). This means that applying certain
conditions to oil & gas companies will be different to steel manufacturers on many aspects
40
.
Misinterpretations could result in unnecessary concerns regarding suppliers, wrong decision
making, resulting in the failure to detect financial weaknesses or miss-allocating risk
management resources.

Additionally, the change for supply managers is that they are not as interested in comparing
one companys financial performance with another for the investment purposes, but rather in
the interest of knowing whether a supplier will have the financial resources to stay viable in
the future. The supplier does not have to be the most profitable in its category to continue to
be a useful collaborator (Carter & Giunipero, 2010).

38
For example, the risk with a supplier that is financially unstable, protection might be required to negotiate
licenses and escrow in the event the supplier starts to fail financially. Then, in some cases dual source the item
which will cost more because volumes are not maximized and because instead of having to manage one supplier
the firm will need to manage two.

39
Parent organization, the operating unit, or both.

40
Asset utilization if the industry is heavy asset based, current ratio range if the typical firms have usually high
current liabilities or not? etc.

24

Finally, we observe that maintaining a current and continuing flow of information regarding
current and potential suppliers is an excellent way to avoid surprises that result from supplier
insolvency. Without a systematic program of monitoring, early warning signs will not be
detected or put into their proper perspective, and corrective action will not occur in a timely
manner (Beil, 2009). Ultimately, developing a supplier watch list is the end result of the
financial analysis. To help identify suppliers who are at high risk of causing serious
disruptions to the business plans of the buying company.

Beyond the basics

As we have previously mentioned, many of the general evaluation tools often do not give a
precise enough picture of a companys financial setting. However, depending on the needs
and goals of each supplier financial review
41
other types of more focused and detailed
methods can be deemed more appropriate (Helfert, 1997).
Furthermore, academic literature consistently denotes that caution must be exercised in
relying solely on financial ratios for completing a sound company analysis. Though there is
no one-size-fits-all model, according to (Wright & Gallun, 2008) it is important to ask for
detailed documents, extra research, efficient analyses and alternative evaluations in
performing a thorough financial assessment develop a multi-sourcing approach.

Specific indicator research
According to (Damodaran, 2009) some companies warrant more in depth examination then
others, due to various shortcomings in specific areas, falling outside the general scope of
standard ratio analyses. In order to mitigate potential risks later in the procurement process
and provide an in depth vision, focused research on a specific problem factor/element
42
may
be warranted.
The cash burn ratio is an example of a cash focused study (Robinson, et al., 2012). It intends
to help interested parties
43
to decide which company they should invest / partner up with,
depending on their short term future. Similar possibilities can be, conducting a thorough cost
structure analysis, evaluating order book levels to understand decreasing sales, project
attribution percentages and many other types of studies, helping to put factors of concerns
under the microscope. However, these are not considered standard analyses and should not
always be undertaken
44
due to different time constraints and possible redundancies.

41
Just to qualify, put on bidder list, potential viable supplier or add to internal database, etc.

42
Cash flow, leverage, payables, and account receivables.

43
In our procurement setting, Total S.A wishing to invest in a partnership with said supplier.

44
Depending on specific needs, focused identified weaknesses or for confirmation.

25

Qualitative Analysis
A qualitative analysis is a companywide investigation that uses subjective judgment based on
non- quantifiable information
45
.

However, while most investors and analysts rely largely on quantitative measures and metrics,
improving the evaluation with qualitative analysis increases the insight into the company
(Cancro & McGinnis, 2004). Using qualitative factors will often give an edge since key
factors, such as management, future strategy, geographic diversity, does not show up in
quantitative analysis. In a procurement setting, this analysis is fundamental as supplier
selection involves dealing with many elements and non-quantifiable information that must be
taken into consideration.

Stress tests (scenario analysis)

Researched by (Quagliariello, 2009), stress tests and scenario analysis have been widely used
in many sensitive sectors like Oil & Gas in order to determine the ability of a company to deal
with specific indicators
46
. The potential variations are tested and an assessment of the
robustness of the financial structure is delivered. These tests may use the stresses such as:

What happens if taxes fall by z% in a given year?
What happens if interest rates go up by at least y%?
What happens if oil/commodity prices rise by X%?

The Oil & Gas environment is widely influenced by many key factors that tend to have big
correlated impacts on a firms financial health (Shimkus, 2011).

Hence it can be useful for supplier selection to see how sensitive or volatile the potential
partners activity and its well-being is dependent on these key factors as well as others (for
example: a piping firm shows an exposure to steel price variations of up to 50%, will tell us it
is too sensitive to this factor and thus a risky supplier).

Risk Analysis

Oil & Gas firms are working hard to improve the risk management setup currently in place.
Given recent market events, the impact of regulatory change and large-scale liquidity crises
are taking on an increasingly important role and warrants higher risk awareness reports
(Crockford, 1986).

45
Management expertise, industry cycles, strength of research and development, geographic diversity, regulatory
framework, political influence and dependency, financial policies and labor relations, just to name a few.

46
Crashing cash positions, increasing short term debt levels, falling margins, raw material costs, etc.

26

Ultimately it is important to not forget the key role that risk considerations /analysis plays
within all these processes, methodologies and evaluations. Thus, it is vital when evaluating
the financial health of suppliers to, when needed, perform specific risk analysis (Aven, 2003),
taking into consideration acceptable risks levels
47
.
In finance, risk is the chance that the return realized on an investment will be different from
that expected, and also takes into account the size of the difference. This includes the
possibility of losing part or all of the original investment. In a view advocated by
(Damodaran, 2012), risk includes not only "downside risk" but also "upside risk"
48
.
As stated by (Horcher, 2005) all the main financial risks
49
, can to some extent be related,
calculated or taken into account via a financial analysis, thus participating in the risk
management process. However the remaining uncovered risks may warrant extra focused risk
analysis, especially when dealing with major projects whose impact on a firms operation is
colossal.
It is also worth noting the existence of third party risk management companies, such as
(DnBi, Equifax, Company Watch H-score, Beroe or Rapid Ratings), which are not perfect,
but proven risk management tools (Carter & Giunipero, 2010). Nowadays, companies rely
more on third-party logistics services (3PL) and Radio-frequency identification (RFID) to
improve efficiency of inventory tracking and management (Slack e al, 2007).

Credit Ratings

Basel Committee on Banking Supervision Credit risk is most simply defined as the
potential that a bank borrower or counterparty will fail to meet its obligations in accordance
with agreed terms.
The history of credit scoring is very short, beginning only about six decades ago and recently,
credit scoring techniques have been expanded to include more applications in different fields
such as supply management. Credit ratings, determined by credit ratings agencies (D&B or
Equifax for small private companies and Moodys, Fitch, S&P for the big publicly trade) are
widely used for the evaluation of businesses and more precisely in our case, suppliers.
A poor credit rating indicates an agency's opinion that the company has a high risk of
defaulting, based on the analysis of the entity's history, financials
50
and the long term
economic prospects (Van Gestel & Baesens, 2008).
Moreover, the idea of reducing the probability of a firms default probabilities, which predicts
(customer/supplier) risk, is a new role for credit rating. It can support and help maximize the
expected profit from different partnerships for different institutions and not only banks.

47
Risk that is deemed acceptable for the financial stability of the company and also sometimes necessary
depending on the industry in order to generate certain revenues.

48
Returns that exceed expectations.

49
Credit risk, Market Risk, Operational Risk and Liquidity risk.

50
A sort of financial analysis, where the ratios and other added specific elements (geo-diversity, fleet age,
political stability) are put in different range tables to attribute different grades and give a factor specific rating.

27

Now more than ever, the use of credit ratings /scorings has expanded all over, especially with
the tremendous technologies created, introducing more advanced techniques, alternative
models (Pragyan & Murphy , 2009) and new evaluation criteria, such as GINI and Area
under the ROC curve to name a few. Besides, the high capabilities of computing technology
make the use of credit assessment much easier than before (Hussein & Pointon , 2011).
On top of that, in our (supplier selection/procurement) setting, credit ratings are useful in
determining the reliability of suppliers and their credit worthiness. These evaluations provide
a deeper solvency analysis (Anderson, 2007) of suppliers and can be of great use, when used
in symphony with other tools we have reviewed before. If suppliers present weak credit
positions, then many risks arise from this situation and thus multiple precautionary measures
need to be undertaken to mitigate for impossible collateral damage.
Finally, there are numerous ways that credit risk can be managed (Duffie & Singleton, 2003).
The most important line of defense is the use of credit scoring or credit analysis to avoid
partnerships and extending credit to parties that entail excessive credit risk as we have
reviewed. Credit risk limits are widely used; these generally specify the maximum exposure a
firm/industry is willing to take to counterparty and calculation of exposure under such limits
requires some form of credit risk modeling.

Bankruptcy prediction tools

Scoring and statistical methods used to predict and showcase bankruptcies are also of good
value as part of a complete financial assessment, if interpreted correctly. In a supplier
selection setting, knowing if a company has a tendency to become bankrupt is an essential
factor. However, like all statistical techniques, no method is fully sound proof and it contains
a certain amount of % error. It is thus important to understand the shortcomings of these
tools, how to best mitigate them and work past these issues.
In his initial paper (Altman, 1968) elaborates one of the most common and well known
scoring tools today, called the Altman Z-score. His work is built upon research by
accounting researcher (Beaver, 1966) and others such as (Fisher, 1936). He displayed the use
of a new type of prediction model, supposed to be more efficient than traditional ratio analysis
using comparing methods.
Put in a Multi-Discriminant Analysis (MDA) model, traditional ratios have shown a much
higher power of prediction of bankruptcy. Notably, this has allowed companies to predict
corporate bankruptcies amongst their suppliers.
This model, in the end, would allow a company to classify suppliers as having high, medium
or low risk of bankruptcy filing. While it is primarily meant to be used with public companies
with data in public SEC filings, it could also be used with private companies who could be
required via different processes to share this information. Furthermore, it has been observed
that the model can be adapted / tailored to reflect different specific industrial or sector
settings
51
.

51
For Oil & Gas companies, the order book ratio is a very important factor. Even so, that after research, it could
prove to be more important than one of the 5 pre-established ratios. This research area is growing in importance
as it could help develop specialized and segment oriented statistical models such as the Piotroski, Zeta and Z
score. In turn helping ameliorate overall bankruptcy model accuracy and better risk management processes.

28

It has been noted that when a firm starts bearing a loss or decline in the profit, it should be
required to predict its possible insolvent stage. However, the interest of insolvency is confined
in the academics and restricted to few journals and books. One of the possible reasons for not
developing the model for insolvency is difficulty in calculating the results (Kleinbaum, et al.,
2013). However after the increased usage of computers, more and more models have been
developed for insolvency. Nonetheless, (MDAs) and other prediction models have been
considered neutral due to their too rigid modelling properties
52
.
Moreover, today so many different types of scoring, grading and rating tools exist. All with
their own specific set of variables or situational settings which does to some extent show the
lack of a common assessment technic for company financial evaluation (ex: Piotroski Score or
Beneish Model). Furthermore, over the recent years many academics and research papers
have tried to show with some success the inefficiency for the Altman score to predict
bankruptcy nowadays, 55 years or so after the initial research was conducted. The most
noteworthy disapproving parties have been (Shumway, 1999) and (Chava & Jarrow, 2004)
who showed increased accuracy in their models and how the Z-score was no longer predictive
of bankruptcies within our present environment.
Despite these critics, the ease of use and easy modifications to the model made sure the Z-
score gained wide acceptance. It is especially appreciated and mostly used with auditors,
management accountants, courts, and database systems used for credit evaluation (Thomas, et
al., 2004). The formula's approach has been implemented in a variety of contexts and
countries, although it was designed originally for publicly held manufacturing companies with
assets of more than $1 million. Later on, variations by Altman were designed to be applicable
to privately held companies (the Altman Z'-Score) and non-manufacturing companies (the
Altman Z"-Score).
Some while later, (Gepp & Kumar, 2008) incorporated the time bias factor into the classic
business failure prediction model, using (Altman, et al., 1977) and (Ohlson, 1980) models.
Prediction instruments have only been getting more and more complex and comprehensive
(Mertons DD or CHS models, see Appendix Link 1 & 2), always trying, maybe at default to
quantify and standardize information, simply not meant to be.
Nevertheless, according to (Kendall & Stuart, 1973), the failure of the complete prediction
tools developed the basis for ratio analysis. The prediction models are useful for the large size
companies, however they do not present an accurate vision of small size companies.
According to (Robertson & Mills, 1991), the prediction model is found to be industry specific
and for the specific firm size which cannot be useful for the smaller types of businesses.
There have been multiple studies conducted to determine the financial criteria for small size
companies that are to be predictive to them. One of them, (Laitinen, 1991), calculated 19
financial ratios of small size companies to develop a predictive model similar to that of
Altmans, but without significant improvements. Finally, the research conducted by (Kendall
& Stuart, 1973) as well as many others after him, stated that the predictability of these
statistical models was dependent on the independent choice of the financial ratios and the
method which is being used for calculation purposes according to different settings. Hence,
we observe a partial return to human selection and showcase the limits to standardization.

52
Hard to take into consideration qualitative data, complex to retrieve and lack of quality figures. Also add,
unaudited accounts for private firms, the need to develop a model specific to every possible/existing business
segment and dependent on the size of each analyzed firms.

29

As we have noticed, there is room for cross empirical research between statistical modelling
and accounting tools as this is a widely undeveloped area of focus. Ultimately, we will
establish our own corporate evaluation model, based on previous research and specific to the
Oil & Gas sector in the later practical section and see what conclusions we can draw.

Section Overview

We have seen financial performance evaluation is vital for the triumph of an enterprise.
Where, ratio analysis is a convenient way to summarize large quantities of financial data and
compare the performances of different firms (Brealey & Myers, 2003). Likewise, ratios
provide useful figures that are comparable across industries and sectors, allowing different
parties to develop a feel for a companys attractiveness based on its competitive position,
financial strength and profitability. Additionally, no technique is full proof and it must take
into account its own limitations to be combined with other tools and provide a multi-
dimensional vision of a companys financial viability.
Furthermore, we observed in parallel to the development of ratio analysis that many diverse
statistical models have been trying to interpret more and more data. However the fact remains
that over the course of recent years and newer research, this tendency of standardizing to an
extreme has not proven to be efficient, especially for smaller firms
53
. Many practitioners seem
to have forgotten when exploring these topics that other techniques exist outside the scope of
what they have developed or work with on a daily basis
54
.
Nevertheless, this may be at the expense of development and synergies hampered by this lack
of vision, missing the essential links to create cross processes and instruments. From a purely
academic view we can see over the course of the past decade, popularity has switched back
and forth from prediction models and diverse statistical technics
55
to resort back to traditional
financial and ratio analysis and its well know limits. Where, in both cases the accuracy of the
data is an integral and important part for evaluating the company performance (Conti &
Arnaldo, 2008).
Finally, we have learned that, through past inefficiencies lies possible solutions. They will be
pursued in our next section and could steer the next steps and orientation of research in this
domain. Where, a simple yet powerful combination and association of previously developed
tools, recognized methodologies and a new working process for the Oil & Gas industry will
be tested. With the final goal being, to develop a unique warning and categorization model.
Ultimately, developing a supplier watch list will be the end result of the financial evaluation
process. This is where our upcoming practical section will attempt to examine the financial
viability of suppliers in the Oil & Gas sector and warn for possibilities of disruptions. All of
this with the long term objective to help identify suppliers who are at high risk of causing
serious damage to the business of buying companies.

53
Problems with access and quality of data, smaller firms do not function the same as bigger firms. Additionally,
these companies do not always follow standard financial management rules.

54
Management accounting, corporate finance, statistical tools, etc.

55
Enhanced by always more complex processes, capable of treating more data, taking into account qualitative
measures, but always with real world limits.

30

I I ) Supplier Selection Process

Introduction

Increasingly difficult market conditions, continuous technological advancements, higher
competition within a global setting and increased environmental consciousness have forced
organizations to develop their supply chain and put more effort into the supplier selection
process (Tracey & Tan, 2001).
Supplier selection is the process by which rms identify, evaluate, and contract with suppliers;
it is a critical decision for most organizations. The process deploys a tremendous amount of a
rms nancial resources and has a direct commercial and operational impact on the business
(Ittner, et al., 1999). In return, rms expect signicant benets from contracting with suppliers
offering high value and competitive advantages (Beil, 2009).
Progressively, companies are allocating more resources to their core competencies and
encouraging the outsourcing of non-core activities, which increases their reliance and
dependency on said suppliers. This intensifies the importance of effective vendor selection
and assessment ultimately making a companys success dependent on their sound interactions
with suppliers (Baily, et al., 2010). This step is an important part of purchasing activity for
many firms. Todays consumers increasingly demand cheaper, high quality products, on-time
delivery and excellent after-sale services, putting companies under intense pressure.
Therefore, an efficient supplier selection practice needs to be in place and is of paramount
importance for successful supply chain management.
Ultimately, this academic review section describes the typical steps of the supplier selection
process, which is generally considered a five phase system (Sonmez, 2006). It starts with, the
realization of the need for a new supplier, determination and formulation of decision criteria,
pre-qualification
56
, final supplier selection; to the monitoring of the different suppliers
57

(Choy, et al., 2002).
(Figure 3): Supplier Selection Process Outlay.

56
Initial screening and drawing up a shortlist of potential suppliers from a large list.

57
Continuous evaluation and assessment.

31

Supplier Selection Method

1. Problem Definition

The first phase is described as finding out what an organization wants to achieve by selecting
a supplier (de Boer, et al., 2001).
More specifically, this step consists of deciding whether a problem can be solved or not by
selecting one or more suppliers. This phase is crucial to help the buyer in solving its exact
problem(s) and preventing it from dropping a supplier for wrong reasons (e.g. the suppliers
delivery/quality problems was actually due to outdated information being communicated).
Generally, the problem definition phase is an underdeveloped area in literature, yet important
to recognize to grasp a better understanding and appreciate the next steps (de Boer, 1998).

2. I dentifying potential suppliers

Developing existing suppliers is one thing, but in todays fast paced business environment, it
is critically important to discover new suppliers capable of bringing in different competencies
(Beil, 2009).

Importance of new suppliers

Several factors make new suppliers important (Mwikali & Kavale, 2012). First, there may
exist new suppliers that are superior in some way to a firms existing ones
58
or, a new supplier
may have a structural cost advantages
59
. Second, existing suppliers may go out of business, or
their costs may be increasing. Finally, the purchaser may require other vendors only to drive
competition, decrease supply disruption risks, or meet further business objectives
60
.

Reasons for supplier qualification screening

Finding a viable new supplier is challenging mostly due to the need to verify the suppliers
aptitude to meet the buyers myriad of requirements (Hedderich, et al., 2006). Supplier non-
performance on even the most rudimentary level, and for the simplest product or service, can
have dreadful consequences for the purchaser.

58
For example, a new supplier may have developed a novel production technology or streamlined process which
allows it to significantly reduce its production costs relative to predominate production technology or processes.

59
For example, due to low labor costs or favorable import/export regulations in its home country.

60
Supplier diversity, geographic obligations, strategic goals, etc.

32

A good industrial example would be the (Boeings 787 Dreamliner, 2007) production sched-
ule which was considerably affected by shortages of a key component called: fasteners
61

(Lunsford & Glader, 2007). Moreover, in consumer products many safety issues have been
traced back to suppliers failing to meet a buyers requirements, resulting for example in dan-
gerous components found in toys (Plungis, 2010) or faulty car parts like the GM ignition
switch problems (Lienert, 2014).

Production delays due to mismanagement or poor logistics and recalls of faulty products pro-
duced by noncompliant suppliers have cost buyer firms millions
62
and have inflicted untold
damage on their reputations, brand value and future revenues potential.

Supplier qualification screening process

In order to avoid the dire outcomes of supplier disruptions, buyers typically take proactive
steps to confirm a suppliers qualifications prior to awarding them a contract. The primary
goal of supplier qualification screening is to reduce the likelihood of vendor non-
performance
63
. A secondary goal is simply to ensure that the supplier will be a responsible and
reactive partner in the day-to-day business relationship with the buyer (Hedderich, et al.,
2006). This process involves many aspects such as (reference checks, financial status evalua-
tion
64
, surge capacity availability
65
, indications of supplier quality and proof of certifica-
tions
66
, ability to meet specifications / capabilities
67
) and can be expensive as well as time-
consuming.

Creating a supply base

Suppliers who have passed the qualification requirements and are suitable for contract
award are typically referred to as pre-qualified suppliers (Beil, 2009). If the buyer uses
short-term contracts or frequently re-procures the same item, it would makes sense to estab-
lish a set of pre-qualified suppliers competing for these contracts. Finally, using a supply base
not only lessens, qualification screening costs but also allows for the development of stand-
ardized contracts, terms and conditions for pre-qualified suppliers, helping minimize adminis-
trative processes.

61
Essentially bolts that secure sections of the fuselage together.

62
Through recalls, warranty costs, and associated inventory adjustments.

63
Late delivery, non-delivery, or delivery of non-conforming / faulty goods.

64
See section 1 Financial evaluation tools.

65
The suppliers capacity to increase delivery quantities within short lead times is important as the buyer may be
uncertain about their exact quantity needs over the life of the contract.

66
The buyer might require that suppliers have ISO 9000 certification, 2008 certification or Malcolm Baldrige
National Quality Awards (or similar). These indicate that the supplier has policies, procedures, documentation,
and training in place to ensure continuous adherence to quality standards.

67
Request samples of supplier products to test them, visit the suppliers production facility and audit the
production facilities.

33

3. I nformation requests to suppliers

Once the purchaser has identified potential suppliers, the next step is to formally request that
the vendors provide information about their goods or services (Monczka, et al., 2011). Gener-
ally, the buyer makes one of three types of information requests to suppliers:

Request for Information (RFI) is issued when the buyer seeks to gain market intelligence re-
garding what alternatives and possibilities are available to meet the buyers needs
68
.

Request for Proposal (RFP) is issued when the buyer has a sense of the marketplace and has a
statement of work
69
which contains a set of performance requirements which it needs ful-
filled
70
. Suppliers respond to the RFP with specifics on how they would fulfill the buyers
performance requirements and the price they would be willing to accept to do so
71
.
Request for Quote (RFQ) is issued when the buyer can develop a statement of work that stipu-
lates the exact specifications of the good or service needed
72
.

4. Contract terms and negotiation process

The supplier selection process culminates in a contract between the buyer and one or more
suppliers. The information received from suppliers via the requests described previously ulti-
mately must be converted into formal contractual terms before contracting can occur.

As seen next, when making contract award decisions the buyer considers each suppliers qual-
ifications as well as the contract conditions
73
they offer. Contract terms, can be negotiable
between the buyer and supplier (Monczka, et al., 2011), who use different technics to deal
with various situations (Take-it or leave-it approach, competitive tendering or simple bargain-
ing).

68
Typically the buyer asks suppliers what goods and services they could potentially provide, what differentiates
them from other vendors in the marketplace, etc.

69
A statement of work (SOW) is a formal document that captures and defines the work activities, deliverables,
and timeline a vendor must execute in performance of specified work for a client. The SOW usually includes
detailed requirements and pricing, with standard regulatory and governance terms and conditions.
70
For example, the RFP may describe a formed part with certain strength, flexibility, and fire resistance
requirements, but not specify the particular composition of the material.

71
Upon learning the suppliers proposed pricing, the buyer may revise its requirements and/or negotiate exact
terms with suppliers. Thus, the process is generally iterative. An RFP is appropriate for procurement of items that
are non-standard or highly complex, requiring supplier input and expertise about the best way to meet the
requirements set forth in the RFP.

72
For example, if the buyer seeks a part made of a particular valve and formed to a specific set of thickness,
density and shape specifications. Typically there is no need for detailed negotiations with suppliers after bid
receipt, as lowest price or some other objective criteria is used to evaluate bids. Due to their up-front
specification requirements, RFQs are appropriate for procurement of items that are standard and well-known in
the marketplace.

73
Price, delivery standards, and quality.

34

5. Supplier evaluation and contract award

This segment defines how the purchaser evaluates suppliers, decides the contract winner(s),
and puts in place complementary monitoring to inform its future supplier selections. Supplier
evaluation is the process by which the buyer attempts to rank the different suppliers (Benton,
2009). The buyer then uses this ranking, along with other business considerations, to deter-
mine which supplier(s) will be awarded the contract qualification. Finally, after granting the
contract the buyer can monitor supplier performance and use this information during future
supplier selection processes.
Supplier evaluation criteria

The buyer begins the supplier evaluation process by identifying the dimensions or criteria
it wishes to use when assessing suppliers, they should reflect what the buying organization
demands from a potential supplier
74
(de Boer, et al., 2001).

Several literatures have tried to examine and conclude on the major criteria for supplier per-
formance evaluation, where (Thanaraksakul & Phruksaphanrat, 2009) surveyed 76 papers on
supplier selection in the purchasing literature. They found that price, quality and delivery
were the most commonly listed supplier evaluation dimensions, despite many others were also
used. Hence, (Bhutta, 2003), (Chan, 2003) and Extra Research 1 provides an extensive list
of such dimensions and thorough review of recent literature
75
.
(Figure 4)
76
:

74
If a previous relationship exists with the supplier, selection criteria may already be available, otherwise new
criteria have to be formulated.

75
Buyers often as well employ new dimensions in response to prevailing business issues and challenges.
Dimensions that have emerged recently include environmental and social responsibility, safety awareness,
domestic political stability, cultural congruence with the buyer organization, and terrorism risk.

76
Ranking of the most important selection criteria first conducted by the famous (Dickson, 1966) research and
later reviewed and compared by (Cheraghi, et al., 2001).

35

As seen in (Table 1), the most important supplier selection criteria complied in the mid-1960s
was price and delivery (Dickson, 1966). However, recent studies have discovered a shift away
from price as a primary determinant of supplier selection (Bevilacqua & Petroni, 2002).
Several writings point out that the supplier performance is not just related to price or quality,
but instead, requires a multi-criteria evaluation process (Kwong, et al., 2002).
Moreover, (Tracey & Tan, 2001) detailed in their study that effective supplier evaluation is
not easy to achieve if the customer relationship and satisfaction is not considered. Therefore,
the buying companies need to select and identify the evaluation criteria which will serve the
companys objectives, activities, and satisfy the customers.
Additionally, (Ohdar & Ray, 2004) cited that there are two main performance measurement
attributes which are soft or non-quantifiable criteria like supplier commitment and hard or
quantifiable criteria like supplier capability. This set of relevant supplier selection dimensions
changes over time as a natural adjustment to changing business atmospheres and competitive
environments. According to (Scott & Westbrook, 1991) is it likely that a strategic approach of
purchasing has influenced this process and created new sets of more soft character criteria
for supplier selection (Verma & Pullman, 1998) such as the buyer-supplier relationship.
However, the relative importance of each criterion varies largely due to the nature of the
situation and what industry the organization operates within (Ellram & Carr, 1994). This
implies that there probably cannot be a generalized consensus on how to weight the relative
relevance of the different criteria (de Boer, et al., 2001). Very recently, (Sivapornpunlerd &
Setamanit, 2014) identified a detailed series of 4 main-criteria with 18 sub-criteria for
performance evaluation, detailed in the following (Figure 5).

36

Furthermore, these vendor selection criteria are used in the selection process of suppliers, but
can also be used as key performance indicators later to evaluate the suppliers. Finally, due to
the complex nature of the supplier selection process a profusion of criteria might occur and
not all managers might consider the same criteria as relevant (Harps, 2000).

Supplier Performance Evaluation Methods

Once suitable dimensions are identified, the ability to categorize suppliers is crucial for
reaching an informed supplier selection decision. The different methods are the models or
approaches used to conduct the selection process (Li & Fun, 1997); they are extremely
important to the overall appraisal and can have a significant influence on the overall results.
Moreover, it is central to understand why a firm chooses one method or a combination over
another to meet the companys specific selection needs. Most supplier-evaluation models
make use of multi-criteria approaches (Muralidharan, et al., 2002), with both quantitative and
qualitative variables. The inclusion of both variable types guarantees the robustness of the
analysis (Bhutta, 2003).
A variety of methodologies are proposed in the literature, but according to (Shil, 2010) exist-
ing methods for the supplier selection problem can be broadly classified into four principal
categories (Elimination methods, optimization methods, probabilistic methods and other
methods). In addition to (Weber, et al., 1991), (Amid, et al., 2006) also provide a short but
insightful overview of the supplier selection research. Interested readers should refer to (Chai,
et al., 2012) and the Extra Research 2 & 3 for more in depth reviews on the specificities of
each methods.

Finally, in general, the guiding factors in determining which system is best are the ease of
implementation and overall reliability of the process. However, it must be pointed out the
interpretation of the results from any of these systems is a matter of the buyers judgment
(Benton, 2009).

6. Contract award and decision making

Once the buyer has chosen a sound methodology and its relevant criteria for appraising ven-
dors, the process of contract awarding can begin. Supplier evaluation and financial appraisal
are key components in this process, but award decisions often hinge on more than just how
the buyer assesses the supplier
77
(Thanaraksakul & Phruksaphanrat, 2009). Sole-award con-
tracting may be used if it is overly pricey or risky to deal with multiple suppliers. For exam-
ple, the buyer may be sourcing an item with high intellectual property value
78
and needs to
closely monitor the supplier to prevent any leakage of this sensitive information. On the other
hand multiple-award contracting can be useful if the purchaser wishes to diversify its supply
sources to mitigate disruption risks.

77
Strategic alliances, geographic proximity or brand image.
78
Fabricating a patented product.

37

In general, there are many factors which might tip the scales in favor of one supplier or anoth-
er
79
. Regardless of which award criteria are used by the purchaser, making sure they are clear
and understood makes it easier for the organization to monitor its contract award decisions
(Cormican & Cunningham, 2007), to ensure the reasons behind the contract award are
sound
80
.

7. Supplier monitoring

Finally, many contracts specify the provision of goods or services over an extended duration
of time, ranging from weeks to years. Hence, monitoring supplier performance during the life
of the contract has several aims. For example, it warrants quality if the buyer inspects incom-
ing goods to certify they conform to quality specifications. Monitoring also supports cost con-
trol as if there is a problem with delivery, it can be identified and handled with the supplier.
Finally, monitoring is most important in so far as it helps the purchaser make better informed
supplier selections (Ittner, et al., 1999) with future transactions and helps anticipate potential
disruptions.

SUPPLIER RISKS

According to (Manuj & Mentzer, 2008) identifying the risks involved in selecting suppliers is
the first part of understanding the possible impacts on the entire supply chain, operations and
finances of the customer / manufacturer. These disruptions can have significant bearing on a
firm's short-term performances as well as long-term negative effects on financial positions
and strategic operations (Sarkis & Talluri, 2002). Thus, it is important to understand the
organizations total exposure to a supplier and obtain timely and relevant information
depending on several factors
81
.

Supplier risk consists of events that have outcomes detrimental to the sourcing plans that have
been put in place with the supply base (Wagner, et al., 2009). These dealings are generally in
one of two categories (Supplier financial distress and Supplier operational fall-down) and are
often linked with each other. As previously observed, working with suppliers involves several
important risks
82,
also called disruption factors (Christopher & Peck, 2004).

79
Preventing monopoly creations, favoring incumbent suppliers to foster trust and loyalty, supplier location and
supplier diversity.

80
Due to the merits of the bid.

81
Strength of relationships, Level of influence/control, Local rules on financial information provision and
Cultural and behavioral habits.

82
Legal, country, operational and reputational (refer to figure 6 hereunder).

38

(Figure 6) Supply chain risks and the related descriptions:

Moreover, the failure of a critical supplier or of a suppliers key vendor can have a severe
impact on businesses (ManMohan & Tang, 2012). For instance, legal disruptions where a
vendor such as a drilling company would not be respecting environmental safety laws could
receive big fines and simply are booted out of the exploration site. In turn, with the number of
complex laws and regulations, the risk of noncompliance has increased significantly.
Same goes for some companies, who suffered high profiled supplier regulatory violations
83

surrounding their procurement activities in foreign countries, which led to undesirable
publicity and unwanted scrutiny. These types of disruptions can damage profitability, stock
price and market reputation with significant long-lasting consequences (Neiger, et al., 2009).

83
A critical issue for oil and gas companies is that of supplier regulatory compliance (Jacoby, 2013). For
example, the review of a third-party contractor handling maintenance works to see if it follows all applicable
environmental statutes in place (HSE). Another instance could be the assessment of a key contractor in Angola
with respect to international bribery and corruption laws when it obtains licenses or permits for exploration.

39

Meanwhile, operational risks arise when suppliers operational systems do not perform
properly and negatively affects customers, typically, when quality or delivery times are not up
to standards (Carter & Giunipero, 2010). For instance, a supplier to a major oil and gas capital
project creates major delays to an oil exploration program and leads the sponsor in charge to
invest significant time and money in resolving the problem to bring the capital project back on
track.
Likewise, globalization has made supplier risk today more than ever at the center of
considerations (Meena, et al., 2011). As we have seen with the 2011 Japanese tsunami, which
greatly impacted the manufacturing industry of the country. In turn, many industrial sectors
(automobile, high tech, ships) across the globe that relied heavily on parts made in Japan had
no choice but to suspend production when their supply chain was disrupted.
For some time, companies have approached supply chain uncertainty in a fragmented fashion,
with legal, procurement, finance and operations all working independently to manage certain
aspects of supplier risk (Zsidisin, 2003). These unconnected activities, managed separately,
however successful, provide no enterprise-wide awareness and companies lack the
overarching strategy, structure and processes to prevent a costly procurement situation.
Hence, the supplier selection decision requires the intervention of the various services of the
company (Mobolurin, 1995).
Please refer to Extra Research 5 providing further detail on procurement management and
supplier risks.

SRM / SCRM

In 2008-2009, manufacturers experienced the startling speed at which suppliers can move
from stability to shutting down operations. The devastating impact and high cost of resolving
crucial supplier failure has moved risk management from an add-on service to mission-critical
(Shashank & Goldsby, 2009). With this new focus, manufacturers have seen value whether
the economy is stagnant or flourishing and academic studies thrived in developing on the
study of (SCRM) supply chain risk management and supplier risk management (SRM).
To overcome these challenges, companies mitigate supply chain disruptions and reduce risk
with strategies and tactics that address supplier-centric and global
84
risk at various stages in
the relationship (Slack, et al., 2010).
This meant there was a need to create an advanced warning system to later develop an
iterative and continuous process (risk identification, risk assessment, risk treatment and risk
monitoring) of supply risk management (Zsidisin, et al., 2000). Achieving this will minimize
disruption and reduce value destruction as it is not sufficient anymore to rely on historical
financial information, credit ratings and other financial assessment methods.
This means not only appraising the supplier in anticipation of establishing a relationship
(quantify and qualify the cost of supplier failure/disruption to the business), but also routinely
evaluating supplier performance to see if that performance remains at or above the required
standard.

84
Crises or disasters impacting the supply chain.

40

After this, a number of approaches can be undertaken to mitigate overall identified supplier
risks (ManMohan & Tang, 2012). They notably include: periodic reviews, critiques of
supplier performance, efficiency comparisons to competitors, assessment of the overall
continued value of the buyer/supplier relationship. Additional measures include having
prepared and put in place contingency plans (Trikman & McCormack, 2009) for at-risk
suppliers and regularly organizing cross department
85
reviews of key vendors.
Moreover, should the risk evaluation process indicate that a given supplier is no longer the
best fit; steps should be taken to qualify the degree of risk associated with doing business with
a different supplier (Chopra, 2004) and then making a decision on whether to move the
business to that other supplier or not.
However, continual monitoring of the entire supply base is neither practical nor necessary.
The focus must be on those suppliers who, by the nature of their situation in the supply base
(single sources and providers of key items), could create major complications in the event
they experience financial or operational problems that would restrain their ability to supply
the buying firm (Carter & Giunipero, 2010). Using these tools, a few select suppliers can be
continually monitored, and buyers can be provided with advance notifications of supplier
distress that allow them to take action prior to disruptions.

When implementing such process, several key factors are taken into consideration (Ruiz-
Torres & Mahmoodi, 2007) such as the ability of the supplier to provide timely delivery of
products and how it can impact the whole customer supply chain if things go wrong. Supplier
risk management will also be concerned with the quality of the goods and services delivered.
This is because ultimately any reduction in that quality will have an adverse effect on the
reputation of the client and its operations health
86
(Ruiz-Torres, et al., 2013).

Changes in any of the critical factors can be defined as parameters for raising an alert
(ManMohan & Tang, 2012). For example, a financially stable supplier may in fact be about to
lose its CEO to retirement which may cause issues within the management team. Early
visibility into that change gives the manufacturer time to ensure it doesnt negatively affect
operations. However (Bergera, et al., 2004) argue that companies can benefit from the multi-
supplier approach, playing supplier off supplier in order to generate a competition aspect and
obtain the lowest prices and shipping costs. Incorporating multi-suppliers could also decrease
the risk of vulnerability to the chain, as required components can be obtained from another
source in the event of a disruption.

Ultimately, the different benefits in reducing supplier risk is in helping firms deal with their
supplier relationship management in more composed fashion. They, give insight for
manufacturers to create defensive and offensive strategies that turn risk into a competitive
advantage (Buhrmann, 2010). Overall, it position firms on one hand to better understand
supplier risk and on the other helps the vendors to better address customer needs by
addressing supplier vulnerabilities before they become apparent.

85
Procurement, finance and operations.

86
For example, should a supplier that provides steel to a valve manufacturer fill the order with steel that is of
poor quality, the goods produced by that manufacturer will also be of lower quality? Then the customer might
reject the goods or use to produce lower-quality products that must be marketed at a deep discount. In the
interim, additional steel that is up to standards must be ordered and delivered if the manufacturer is to avoid
curtailing operations that could lead to delivering finished goods to a customer, which in turn causes
inconvenience for the end-customer.

41

Specifics of the Oil & Gas Industry

The development and commercialization of Oil & Gas projects often requires a level of
investment or technical skill not possessed by the company, national authority or government
sponsoring the project (Jacoby, 2013). Establishing a partnership is something which is
common place in the upstream Oil & Gas industry. It is a way of securing the required
resources and skills
87
to support and assist the development of the venture; it also allows the
project sponsor(s) to share the different risks and reward. Hence, selecting the right partner(s)
and suppliers has become an increasingly crucial role to the success of any project (Chima &
Hills, 2007).
Moreover, this industry has very long supply chains and many companies may be involved in
supplying the materials, components and services at different stages
88
(Linde, et al., 2014).
Procurement becomes even more important for global operations, where companies such as
Total, Shell or Schlumberger source services and supplies
89
from many different countries and
expose themselves to many types of risks.
Furthermore, reliability is a crucial factor in supply, both of quality deliveries and timing
(Monczka, et al., 1998). If supplies are of poor quality, delivered late or cost more than
agreed; it will affect productivity and profitability (Tan, et al., 1998). Poor quality inputs
could also affect the safety of an entire operation; a major consideration in the oil and gas
industry. For example, to help improve safety and quality of supply, many super-majors have
introduced safety performance indicators into contracts of suppliers involved in high-risk
activities.
Additionally, with the major recent well blow-outs
90
many firms and organizations have
tightened their regulatory regimes and risk management processes (Linde, et al., 2014).
However, despite increasing awareness of the risks that are embedded in the supply chain,
there is still a mindset in the oil and gas industry that supplier risk is just part of doing
business. Meanwhile, managing risks seems to remain an enigma, despite they can be
managed successfully without reducing profits long-term or efficiency, given careful efforts
(Leveson, 2011).
As mentioned before, many energy companies do business in developing countries where
major suppliers may not be available and local suppliers may not have the financial strength
or quality control to be reliable (Chen & Paulraj, 2004).

87
Financial, technical or operational.

88
Extracting, refining and distributing oil and gas.

89
These include mechanical and electrical parts, to professional services such as project management or legal
expertise for drawing up contracts.

90
The largest underwater blowout in U.S. history occurred on April 20, 2010, in the Gulf of Mexico at the
Macondo Prospect Oil Field.

42

For example, very often a compromise must be found whereby a local vendor will work with
the subsidiary of a bigger group supervising the different local operations and processes.
However, insolvency of suppliers within the supply chain can be an issue even in
industrialized countries. For instance, an oilfield services company who recently filed
multiple liens against a US producer who had done business with an insolvent company. In
this case, it would cost several millions of dollars to extricate the producer from this
predicament.
All of the aforementioned cases present risks with serious financial and license to operate
implications that should not be neglected. The good news is that awareness of the need for
improved supplier risk management is growing (Matook, et al., 2009), as more and more
research
91
is being done on this specific subject. For instance a 2012 survey
92
of chief supply
chain officers found that 70 % believed their organization needed to improve existing
processes or add capabilities to improve their supplier risk management. These companies,
including many in the energy industry, could strongly benefit from applying the lessons
learned the hard way by firms caught in different supply chain breakdowns (Leveson, 2011).

Supplier Selection Process conclusions & research

According to (Chai, et al., 2012) supplier selection has attracted significant attention from
academics and practitioners alike because of its perceived importance, its visibility
93
, and its
suitability for formal, mathematical modeling.
Another key element to consider is the relative importance of supplier selection in some
industries rather than others, depending on (level of industrial complexity, logistic process,
upstream integration, legal or safety constraints). Despite not being core to our study, further
development on Supplier Selection research
94
, can be found in Extra Research 4 for
interested readers.
Furthermore, this review exhibits the importance played by vendor selection and financial
assessment on the buying firm's business performances. A strategic commitment and
operational guarantees from suppliers is clearly a vital determinant of business success. Not
only does it directly impact performance as the results demonstrate, but it can also cause long
lasting indirect disruptions (Kannan & Tan, 2006).

91
The chief supply chain officer report 2013- pulse of the profession.

92
Global Chief Procurement Officer Survey - Leveraging Digital Procurement and Innovation to Expand
Procurements Business Value.

93
At least in the sense that the ultimate outcome is identifiable.

94
(The buyer-seller relationships, International suppliers, E-procurement: Online supplier selection and Industry
Specifics).

43

For instance, it is easier to address supplier delivery and quality issues if there is a strategic
relationship between buyer and supplier, and if there are shared expectations as well as
objectives. This is the case, because suppliers are essentially extensions of the buyers
95
.
Finally, results indicate that soft, non-quantifiable selection criteria
96
, such as a supplier's
experience and satisfaction, have a greater impact on performance than hard, more
quantifiable criteria such as supplier capability. Yet they are considered to be less important,
mainly due to the slow acceptance of the supply management mindset with regards to change.

I I I ) Conclusions of the Literature Review

(Sridhar & Subrahmanyam, 2005) talked about the rich and rewarding scope for combining
and modifying concepts from finance to aid supply chain management and model risks in
operations.
We have seen that in the traditional supplier selection literature, financial aspects are usually
very briefly mentioned or researched. They seem to be considered as of regular importance
and a mere conventional part of the process. However, our first section clearly showed us the
different facets of financial evaluation, their implications and the importance it could pertain
depending on the situation. Meanwhile the second part elaborated on the supplier selection
process and its make-up, putting to light already possible areas for further development.
With this review of fundamentals, we are now able to establish more clearly the possible links
between our two main and widespread topics that are financial evaluation and the supplier
selection process.
Ranging from the obvious causal links where financial analysis is used as an assessment tool
for supplier selection and qualification. To the more subtle intricacies, such as the
management of different supplier risks via careful supplier financial performance
measurements. However we have also noticed that in some cases a complete and thorough
financial evaluation is not needed. This is simply due to the nature of contracts involving said
supplier and the environment surrounding the situation. It is thus important to also know
when to use ratio analysis or other assessment technics we have reviewed and when not too
97
.
We have shown that there exist within the financial evaluation dimension alternatives and
focused tests as well as standardized tools more suited to quick reviews when necessary
98
.

95
This, however, requires that firms develop relationships with suppliers that are willing to develop closer ties,
have order entry systems that support the relationship, are willing to share confidential information, and are
otherwise committed to serving the buyer's long-term needs.

96
Willingness and ability to share information or strategic commitment to a buyer.

97
Following carefully the initial steps of supplier selection and not jumping in to performance / financial
evaluation straight away.
98
Time, Cost, Resources and Information causes.

44

Furthermore, it is imperative to understand that there is a limit to what financial analysis
should be aiming to contribute within this process of supplier selection. Where the financial
assessment of each firm, suppliers and potential partners more than often takes the form of a
credit analysis
99
rather than the more investment oriented type
100
of evaluation.
Moreover, we have observed that there is substantial academic limitations
101
and
shortcomings regarding these two topics and their underlying links and we hope to have
reviewed several of them here in our general assessment.
However, we know the research arena and the business world alike would benefit from a
clearer vision and an initial paper on the topic of financial analysis and its importance
within the supplier selection process. Hence, we will test our hypotheses by developing a
business oriented approach in the next section. This will allow us to then craft a more hands
on review with our comprehensive table, outputs & equation, different support tests, scenario
analysis and professional interview.
Finally, all of this is accomplished in partnership with the company Total S.A, enabling us to
connect these different research questions to one another both theoretically and practically
across the business arena.

Chapter 3: Methodology

This section will attempt to develop the practical and business side of our research topic. In a
first part we will review the business environment at our partner company in order to
understand how they develop the different tools and methods we have previously reviewed.
Secondly, we will attempt to give recommendations regarding improvements of their business
processes, focusing specifically on financial analysis, standardized tools and ratio instruments.
Further on, we will explain and detail the methodology we have put in place to develop our
practical section in order to link the two topics together and make our research as complete
possible. In the process, giving insight into the quality and pertinence of our data and why our
approach can be recognized as appropriate to answer our different research questions.

99
Main focus on Liquidity, Solvency and Capacity to operate and deliver said products or services.
100
Main focus on Profitability and Activity.
101
Processes and theories not adapted to the business world, many different techniques never assembled
together. How big a role finance plays in supplier selection?

45

In addition, we will develop a comprehensive table and two outputs (equation model with
score + grading & rating) in partnership with the C&P
102
team in order to create the most
useful, efficient and working business tool.
This research collaboration will enable us to collect pertinent data for public and private
companies such as the confidential bankruptcy data we will use in a scenario study to validate
our newly created process.
We mention that our developed material and the gathered data all help us to hopefully
showcase one thing: The importance of financial analysis as one evaluation method within a
supplier selection context. Hence, by trying to develop our own standardized tools we hope
to portray their different inherent difficulties and limits and relate to our previous academic
review. In turn, informing us about the extent to which these technics can be relied upon and
how could they be used in association with tailored financial analysis methods formerly cited.
Ultimately, this section will allow us to go the extra step after our previous literature study has
set the fundamental theory scene. Helping us establish a new financial evaluation process and
facilitate future research. Whether it is to develop a sector/industry focused model or a
specific business setting instrument.

Objective:
Offer and develop a comprehensive and easy to use financial assessment process to help
mitigate possible supply chain disruptions. In order to do so, we will partly test the current
pool of standardized methods we have observed mistakenly categorize a number of suppliers.
Finally, we will try and bring to light what makes these tools so appreciated but at the same
time criticized for their limits and lack of flexibility. Ultimately, it will enable us to assess
precisely the importance of different evaluation techniques in selecting financially stable
partners and help us towards sounder decision making within the supplier selection process.

102
Contracts and Procurement department at our partner company Total S.A Exploration & Production branch.

46

A) Business Environment

Supplier selection

This section describes the supplier selection process within an energy sector company (Total
S.A). As a successful corporation, it is an extraordinary example about how to select the best
supplier, keeping competitive prices but at the same time maintaining quality and satisfaction
with its clients. Refer to Appendix (Practical Section, Exhibit B N1-5) for the companys
outline of the qualification process and supplier forms sent out requesting the different
information for the assessments.
The Supplier Selection Process at Total S.A follows a traditional procedure as we have
reviewed in the academic section, it is lengthy and thorough enabling them to sort out and
only work with the top suppliers available. However it is very important to distinguish
academics from real world business. Despite following the general guidelines
103
allowing for
a complete process taking many factors into consideration the selection of suppliers is a very
delicate and often tricky job. It requires people working from many departments in different
disciplines
104
and frequently decisions are taken depending on various previously not
established elements
105
. This is why the overall procedure is very dynamic and extremely
tailored to the intangibles of each deal and players involved.
The business world compared with theory is not as clear cut. It is important to remember that
financial evaluation plays a crucial role in determining which suppliers are assessed as
potential partners, leading to additional in-depth reviews.
Finally, since the financial procedure is much shorter and less expensive then (technical, anti
corruption or HSE) analysis, we could say that financial assessment of suppliers plays a sort
of secondary screening process after the initial suppliers have been identified. Where we insist
on the fact that only on rare occasions a non-qualified supplier would be able to work with the
Group
106
. Thus, we underline the worth of such a process time and risk management wise.
Ultimately, this somewhat contrasts with our literature review where the role of financial
evaluation in the selection process has been overly simplified
107
and greatly underplayed as a
topic of attention and research.

103
Starting with the realization of the need for a new supplier, determination and formulation of decision criteria,
pre-qualification, final supplier selection; to the monitoring of the different suppliers.
104
Engineers, procurement managers and financial analysts.
105
Previous experience with the Group, preferences or key alliances, overall strategy and partner
recommendations to just name a few.
106
Exceptional technical advantage, monopole in a sector, only capable supplier in the present setting, etc.
107
Simply reduced to grading suppliers financially and using simplistic and inaccurate methods. Meanwhile
we have shown the vast number of available techniques, there different strengths and the detailed reviews they
could perform.

47

Financial analysis

We review how Total has put in place there financial supplier appraisal process, see Appendix
(Practical Section, Exhibit A N1-19) for further details.

If we observe the different supporting documents, we clearly notice, that Total has developed
a simple semi-standardized, yet efficient and tailored model. The complete process allows to
analyze the financial health of suppliers and there capacity to continue as a going concern.

Initially, the first step in choosing which model or third party tools to use depends on whether
the company is Public or Private. Regarding listed companies, there is a certain ease of
access to their financial information and annual reports. This allows the extraction of data
directly to an excel model very easily and also guarantees a good standard and quality in the
data gathering
108
. Meanwhile, for private companies, the reporting obligations being widely
different and not mandatory, the data will have to be retrieved via supplier contacts or the use
of specialized third party logistic means. In some cases, this may raise certain issues regarding
the validity and exactitude of the financial information retrieved.

As we move on, the objective is to determine based on the supplier type and the situation
which level of analysis will be necessary (Level 0, 1 or 2?) based not only on financial
elements
109
. Please refer to (Exhibit A n1 & 2).

Starting off the process, level 0 analyses are almost always performed
110
and used as a first
step screening routine. They consist of using third party logistics and risk management
sources such as (D&B, Van dijk or Coface systems) to categorize vendors in terms of risk
profiles, see (Exhibit A n3 and 4). Depending on the initial adjudged risk level of the
potential suppliers
111
, Total will know if it is necessary or not to perform a deeper financial
review at the next level or not. This efficiently helps to simplify the decision making process.

Additionally, if the level 0 is inconclusive due to a lack of information or initial negative
credit risk results, then the analyst will initiate a level 1 financial analysis process which is
a method tailored and developed by Total for its specific needs, see (Exhibit A n2).

The initial steps of this procedure are to retrieve the financial data and information from the
different financial statements
112
. Once this material is retrieved there will be a need to extract
and perform the necessary reporting adjustments as the different financial statements and

108
Retrieved from Thomson One banker usually.
109
New supplier, monitoring, excellent technical aptitudes, which might in some cases orient the financial
assessment in some way.
110
Not for public companies as their information (risk wise, financials, market, etc.) can be found easily and
publicly. For examples we can use specialized websites, credit ratings or other free available statistical scores.
111
(High, medium, low).
112
Income statement, Balance sheet, Cash flow statement and other notes.

48

reporting methods differ from one country to another
113
. Various types of information need to
be correctly adjusted to allow for a common interpretation of data and maintain a certain
coherence within the analysis, see (Exhibit A n17, 18, 19).

Moreover, once all the purely financial data is retrieved, another set of information will be
included
114
which activates a set of macro-automated benchmarks for the ratio analysis. The
goal here is to make the companys profile as complete and succinct as possible for the people
reading the financial analysis summarys afterwards, see (Exhibit A n17).

Once all this data/information has been inputted, we direct the attention towards another
section of the model, where a set of various ratios will have been automatically calculated via
a set of linking formulas
115
. Then, the ratio analysis must be performed
116
comparing trends
from year to year, different accounting lines to another and the companies numbers to the
different industry specific benchmarks. On this last topic, a separate document has been
created and linked with the financial analysis model to create an automatic sector/business
segment benchmark for comparisons. Much attention will be put towards reviewing if needed
the notes of the statements and scanning different items for unusual movements. The different
comments and observations pertaining to the ratios will be added by the analyst in order to
make sense of the information and help understand the companys global financial situation.

From this, will be calculated a set of individual section grades (liquidity, profitability,
activity and solvency), who will then be grouped together to form part of an overall supplier
status, see (Exhibit A n15 and 16).

If required, certain specific conditions
117
may warrant an in depth analysis of other factors. To
briefly develop on the level 2 analyses, they are not as common and try to portray the
exposure of the supplier towards Total as well as its capacities to meet financial contract
requirements, see (Exhibit A n1, 2, 7-11). The objective is thus to calculate annually the (%
amount) of business done by the supplier with the Total Group compared to the overall
revenues of said supplier. This amount needs to be (<25%), otherwise the vendor would be
considered highly dependent on Total S.A, warranting certain measures be undertaken to
solve the high exposure issue
118
.

The goal for Total S.A at this stage with this Financial Analysis is to determine the general
financial health of the supplier and its capacity to work well with the company. At the end the
model helps the analyst decide if said supplier should be considered as qualified, qualified

113
In order to make the inputted data coherent within the model, sometimes performing some adjustments is
necessary. Either it is for the D&A, receivables, provisions or taking only certain elements of the overall dataset.
114
Company profiles, geographic location, accounting closing dates, currency rates and sector of activity.
115
Pre-established as the most important set of ratios to be used for the purposes of this type of analyses.
116
Horizontal + vertical + percentage as mentioned in our academic review.
117
Key suppliers or Technically sound yet financially troubled vendors or A new strategic partnership being
established.
118
Contract covenants, size reductions and or segmentation of the agreement.

49

with reserve
119
or not qualified. In the last scenario, the supplier will either be removed off the
bidding lists or an in-depth financial and technical analysis will be performed to help potential
key suppliers turn around their situations.

At last, looking at this methodology we can clearly see that the financial analysis process
plays a key role in the selection and qualification of suppliers as it is a true reference
document and a decision maker. Finally, the methodology for financial evaluation is fairly
simple of use and may warrant further developments to best assess
120
supplier financial
health. Ultimately, depending on the results of the financial assessment different decisions
and risk mitigations technics can be undertaken to provide the needed guarantees
121
.

Recommendations

Here are some recommendations regarding Totals working methods and processes we have
reviewed for the financial evaluation of suppliers.

First and foremost, applying different (filters, screenings or warning models) other than the
traditional Level 0 methods would enable to diminish the amount of financial analyses
level 1 & 2 performed per year. This would reduce time spent, decreasing costs and also
improve the quality of supplier screening.

This is why, in our upcoming practical section we will try to develop and implement such a
screening/warning tool. It will be achieved using a multi-factor reference table based on
comprehensive data, creating different outputs and major possibilities for further modelling
developments. Moreover, questions should be raised about the use of third party sources in
categorizing suppliers and what the reliability of the information they give?
122

Moreover, creating a new section in the model, called systematic analysis. It would develop
standardized tools
123
capable of giving an additional grade within the overall assessment,
without adding difficulty or wasting time.

119
Leading to placing the supplier on special financial surveillance via periodic reviews conducted during
contract performance.
120
On a wider range of analyzed elements and covering more particular scenarios.
121
Letters of comforts, Insurance Bonds, Parent company and or Bank guarantees, contractual obligations and
covenants.
122
How much financial information is retrieved from D&B or others? How efficient is the categorizing of
suppliers by risk levels? How often are records updated? Could Total use the external sources we mentioned in
our academic review?
123
Z-scores, DuPont, Stress tests, Scenario analysis, Credit scores, Cash burn rate and others.

50

Additionally, for more central suppliers
124
in need of a deeper review, a non-mandatory
section of the model for a semi-standard qualitative or risk analysis should be developed.
This would allow a better understanding of the fundamental factors involved in financial
disruptions.

Another new unit would handle extra information, combining a set of 5 key factors from:
the notes of annual reports for public companies, shareholders equity statements
125
, current
news of the sector
126
and the company
127
allowing a better understanding of key elements
previously overlooked in rougher analyses.
Likewise, an interesting idea would be to add a small area in the ratio analysis called tailored
section where depending on the sector
128
to make a set of 2-5 extra specific indicators useful
to measure within the particular sector such as fleet age for shipping companies, adding a
clear personalized feature to each analysis.
At last, if the company were to be public it would be nice to include a segment for market
data analysis to determine how the company is viewed by investors, market analysts and
other outside sources
129
giving us good insight and an exterior appreciation of the business.
As we have come to gather, checking up on the health of a firm requires more than just the
numbers in financial statements. Therefore, we suggest tracking metrics not typically inputted
in a financial evaluation model:

- Marketing and sales tracking with the backlogs and sales pipeline
130
giving a
forward-looking view at what the revenue line will look like.

- Supplier dependency / exposure towards its own vendors.

- New Business-to-Repeat Business ratio
131
where, healthy businesses depend on
bringing in new clients as well as generating repeat business from existing clients, which
will give another appraisal tool.

- Other metrics can highlight more strategic changes in a business, showcasing if a
supplier is staying relevant to the market: Percentage of revenue from new
products/services or Revenue mix by product/customer segment.

124
Previously identified suppliers within the selection process deemed important due to their contract specifics
or strategic ties with the company.
125
As they can give signals about the company's long-term strategy.
126
Economic factors, tightness of labour market, maturity of the industry.
127
Level of demand for services or products of said supplier and the capacity of the business to supply?
128
Develop a macro to automatize the process.
129
Review the market data and movements in the companys stock price, and (P/E) ratio.
130
Prospective work in the sales process.
131
This ratio describes the revenue contribution from new prospects and the revenue contribution from existing
clients.

51

After review, (Total S.A) could also implement a quick factor analysis using the different
supplier analysis it has performed over time in order to review its most important factors
132
.
This is something we will try to work on with a senior financial analyst of the procurement
department in our Master Table to single out the five most important factors in the industry
for financial health assessment.
Likewise, updating the previously mentioned benchmarks regularly is of key importance to
achieve sound comparisons. Benchmarking is very important to establish the positioning of
the analyzed suppliers and helps mitigate risks
133
. Maybe it would be possible to develop an
automatic link or retrieval system of the information needed for the benchmark process, so
that an update is performed every semester or year depending on the established needs.
Finally, we have noticed after close talks with different professionals of the procurement
department that a well-managed global ERP system was missing. In order to achieve higher
efficiency, an easy to use process regrouping many presently separated functions would allow
to prevent performing unnecessary evaluations and keep better track of suppliers
134
.

Ultimately, our main objective in the following practical core will be to develop a
comprehensive table and different useful outputs / tools (general score via a multiple
regression and a grade with categorization of each supplier) specific to the Oil & Gas industry
which will have for goal to reinforce and complement both the Financial Level 1 analysis
but also serve as a warning tool in complement of standard Level 0 testings.

B) Approach & Methodology

Approach

The goal of our Final Management Project is to show how important financial evaluation
135
is
in the supplier selection process. One of the biggest issues we have reviewed so far is the risk
of supplier disruptions, and most of all supplier failure. This has led us to pursue and develop
the following tools and processes.

132
The most sensitive ones, biggest variations and common industrial factors of importance.
133
Using variations from the standard as potential warning signs.
134
Supplier database, financial analysis advancements, risk management and automate other processes.
135
All its different aspects mentioned in academic review.

52

In order for us to best approach this practical section we chose after reflection with our
partners to develop then analyze a comprehensive table. This will enable us to elaborate 2
types of outputs/tools (a score using the model & a grading which incorporates a type
categorization for companies).
Additionally, this approach will help us showcase a lot of interesting features about the Oil &
Gas industry using our widespread Master Table. Meanwhile, the different specific support
tests will portray more in-depth elements at play. Finally, our methodology will allow us to
develop useful tools and processes for our partners which in turn can be used within their
different evaluation processes.
Ultimately, in developing our Master Table we have used the knowledge and experience of
senior managers and analysts to establish the different set of criteria to take into consideration
for our different support tests. This helped us group the unnecessary dimensions together,
avoid noise variables and useless factors to keep only the most relevant elements.

Methodology

1) Create our reference table called the Master Table. Develop our different tools (the 2
outputs), benchmarks, conversion tables, various support tests, scenario analysis and
conduct a professional interview.
2) Elaborate a simple Process using the table and the mentioned tools developed in
complement of it. This will allow us to link our entire research and make sure our tests
and conclusions can be successfully implemented into Totals operational working
methods.

1) Reference Table Master Table

Here is our methodology for the creation of our reference table, outputs/tools, the different
support tests, scenario analysis and interview.

53

First and foremost our (Reference Table) is made of:

Vertical axis:

5 factors were carefully selected in consortium both with a senior financial analyst and
supplier qualification analyst. We decided to work with only these variables as we
observed from many past research and discussions with professionals that when working
with many accounting elements correlation would tend to be an issue. Thus analyzing ten
factors for example would have increased the complexity of our model significantly,
without adding significant explanatory power and clouding our possible interpretations.
Moreover, it is important to mention that our research focuses more on the financial
evaluation side and hence does not take into account as many business and qualitative
factors as a traditional rating for instance (Moodys, Fitch or S&P). On the other hand the
model and process we will put in place has for key objective to be quickly put in place and
easy to use. As well, please refer to the Appendix (Practical section, Exhibit C- N1, N2
& N3) for further details on the elements chosen, their descriptions and sources. This
extra information and proven methodology from respected sources has considerably
helped us in understanding the key financial drivers of the industry and enabling to select
our best-fit factors for our study:

Factor 1 EBITDA Margin
Factor 2 Sales growth
Factor 3 Debt /Equity
Factor 4 Current Ratio
Factor 5 Debt / EBITDA
Dependent Variable Altman Z- score

This axis also includes a unique % weight of the total for each of the 5 main factors. These
weights will have been determined based on a multiple regression we will perform. These
obtained weights from our table will enable us to elaborate an equation that will serve as a
quick evaluation model in the same spirit as a Moodys rating or different scorings for
instance.

54

Likewise, each of these factors + dependent variable are divided into a 10 year span from
2004 to 2013. Additionally, at the end of each time array we will find an average line which
will allow us to perform comparisons of each year to the mean and allow us to perform our
regression. This will enable us to clearly showcase the impact of each element with its
importance in determining the financial overall health of a supplier. Finally, allowing us to
look at a large enough time-frame to showcase relevant variations and help us make
interesting analysis and come to valuable conclusions.

Horizontal Axis:

Moving on, our horizontal axis is made up of the different companies / suppliers we have
selected to perform our analysis on. To use a sample of a sufficient size, yet still manageable
to perform comprehensive analysis, we decided to select 50 suppliers, from the 10 key sectors
of the Oil & Gas Industry. These companies will be of all sizes (ranging from small to huge)
in order to represent best as a whole (data-wise) the variety of this wide sector and will cover
the whole globe in terms of geographic, such is the nature of this industry. Furthermore we
will have two sets of averages present horizontally, one being the sector specific averages and
the last one corresponding to the industry wide average. Establishing these two arrays of
means will enable us to make truly important comparisons as to sector specific variations,
performances versus industry averages, so on and so forth. It will really help our table
showcase a maximum of information on many different levels and with many different
intersections to analyze and discuss.

Once this table is complete it will enable us to retrieve our two objective final
outputs:

The first output we retrieve is twofold. Initially, we obtain an (scoring) equation from
performing a multiple regression on our complete dataset, enabling us to recover the
constant value and our different weights for each of our different variables. The
multiple regression is performed using the Altman Z score as our dependent variable
(Y) and the other 5 elements used as our independent variables (X1 X5). Data wise,
the Z - Score is relevant as a dependent variable as it is one of the most well-known
and worked on technics in financial company assessment. Its ease of use, despite some
well documented limitations, suits our research well in helping us put in place a useful
yet simple scoring and implement a strong working process (validated in our interview
with a Financial Analyst).

55

Moreover, we have used a 10 year period to create an average for the Z-score. This
enabled us to be as accurate possible and link well with our other elements 10 year
arrays and allowed to flatten (reduce the impact of outliers) the possible variations
within the scoring. Finally this equation will then be used on each singular supplier
data to obtain an overall but individual company score which we will be able to use in
link with our next output.

Second, a benchmark/range to analyze and evaluate the assimilated scoring will be
fashioned based on a detailed process and a set of different factors
136
. Moreover, we
will elaborate a table to make the range selection as clear as possible (for all the
explanations and details please refer to Appendix (Practical Section, Exhibit C - N3).
This developed industry benchmark will enable us to convert the overall score into a
grade out of 10 (0 being the lowest and 10 the highest) which will then be sub-divided
into 4 types of company rankings. This grading and rating (risk factor) will enable
us to rank companies by types (from 1 -best to 4 - worst) and assess quickly of their
financial soundness. The least risky companies will be of type 1 and 2 and the most
risky of type 3 and 4, however special focus should and will be dedicated to the lowest
type 3 and 4 suppliers.

We can clearly observe that the aforementioned table, outputs and even the (range, benchmark
or conversion tables) can be considered as comprehensive and flexible tools which can be
modified according to the different needs and specific circumstances.
In our case it will enable Total S.A first to score suppliers using a fast and simple proven
equation to judge of the financial viability of suppliers. In a second fold, allowing them to use
the developed range, the wider grading and categorization of companies to help their decision
making process within the supplier selection procedure. Meanwhile, maintaining a thorough
quality of results based on a set of carefully analyzed and selected elements and diverse risk
factors. Hence, this will allow Total to see if further detailed analysis should be implemented
or not depending on which suppliers show the lowest grades and rank.
Finally, our partners will greatly benefit from these (priority / warning / decision / assessment)
tools and methodology to identify these possible suppliers prone to difficulties and assess the
situation in a more complete, financially secure and swift fashion.

136
Benchmark table, previous sectorial studies and an interview with Total senior financial analyst.

56

2) Data validity for our Master Table and Tests

With regards to our data, our present study covers one public industry (Oil & Gas), across the
entire globe and is not specific to any particular exchange. Furthermore, we define the Oil &
Gas industry as those companies primarily engaged in Oil & Gas exploration and production
(generally referred to as upstream activities) and refining and marketing activities (generally
referred to as downstream activities).
The main sample of companies we used to establish our tests has been selected on a
convenient basis and once more in council with our partners. We decided to take 50 suppliers
from the 10 biggest sectors of this industry in order to give us an appropriate proxy for our
study. To make sure the representation was at its best we took companies of various sizes, all
geographies and no discrimination elements were involved in the selection process. The final
list was presented to a Senior Financial and Supplier Analyst, to be vetted and approved as
representative of the sector
137
. Also important, the data retrieved can be based on different
types of currencies as our variables only include ratios or % growth
138
.
Moreover, the necessary data to calculate our 5 variables and the Altman score has been
retrieved from various sources
139
since it only dealt with financial accounting information.
The reference table uses data spanning from 2004 to 2013 (10 year array) which was
established as representative for the purpose of our study. Because of the high cyclicality of
the industry, nancial ratios vary widely through the cycle, hence the importance of retrieving
averages over a significant time period to minimize cyclicality effects.
This data was chosen on purpose to be accessible and the most complete possible, hence our
choice to deal with only public companies for our 50 supplier list. As we have seen, a main
area of concern was the availability of private company data and their lack of reliance.
However, with regards to our different tests and scenario analysis we will use data from
bankrupt or near bankrupt companies (public and private), hence our need for valid and
reliable data. This information is of crucial importance in the sense that it will enable us to:
assess our developed tools (grading and company type ranking) and input in our reference
table different bankruptcy data sets. Thus, allowing us to stress-test our findings under
extreme conditions which are always very indicative of major variations. Hence, our partner
Total has gracefully allowed us to use their retrieved audited and or approved financial
information for different suppliers who have gone bankrupt or are in the process of doing so.

137
At least for the basis of our study.
138
Foreign exchange issues do not apply in our case.
139
Orbis, Thomson one, Bloomberg, Google/Guru finance, Total archives and Annual reports.

57

Additionally, with regards to the comparison grading table we are creating as part of our
test section, the data for the different scores we retrieve comes from reliable sources:

- Altman score and Piotroski score: Guru Finance, Thomson one, Total studies and archives.
- Moodys risk score: Official Moodys website and Total S.A access to complete paid
reports.

This ensures that our retrieved information is of high quality, from reliable sources. All
elements are obtained in consortium with our partners and guarantees us objective test results.
Furthermore, this data was not readily available in one place and was recovered from various
archives, other departments and collaborators. Contacting different managers, consulting
databases, dealing with technical people in order to get the clearest and most detailed data
took a great deal of time and effort.
Additionally the bankruptcy data did not always cover a ten year period. However, this has
not been a problem as we used it only for test control in our scenario case once the modelling
section was established. Despite the extensive process to retrieve these numbers, our goal of
making this research a foundation paper for many other studies to build on, pushed us into
being as precise as possible in the collection of data, which entailed several hardships.
Nevertheless as you can imagine this paper does not have the presumption and intent of being
an extremely focused study, but more of a bridge connecting two concepts never linked
before. Thus, many other people will be able to use this research as a first gap project, for
them to later on pursue their own business segment focused analysis. Moreover, our study
time period being very close and up to date, gives a clearer and easily interpreted meaning to
our data. On top of that the figures proved to be readily available, coherent but also current,
taking into account the present environment and newest disruption factors in play.
Finally, the limit of our data comes from the size of the sample and width of research. We
could have chosen to focus on 1 sector in specific and taken 50 companies; however we
wanted for the purpose of our new linking topic and study to cover a wide enough area in our
study. In turn, giving birth to possible business segment focused research. Moreover, our data
could have gone further than 10 years back analyzing up to 20 or 25 years back, however
once again for the purpose of this study it was not of extreme relevance to do so and would
have been too time consuming taken into consideration our constraints. Lastly, it would have
been ideal and interesting to add more private company data and also bankruptcy figures in
the initial research to obtain our equation and its weights. Nevertheless, after discussions with
our partners we agreed this data would be too difficult to retrieve. Also, to a lesser extent, it
may have clouded our overall results due to the quite different features in terms of disruptive
events according to the different sectors.

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Additionally we realize that our reference table and tools/model make it hard to use for
private companies since it requires a lot of information
140
. We did have the possibility to
access 50 private supplier data in our case. However Total suggested for the purpose of our
new research to focus on public data and concentrate on simplicity of comparison. Since,
concentrating on private companies would ideally necessitate an initial paper for
comparison/benchmarking purposes. For private firms study, access to relevant data will be
fundamental
141
and it would make more sense to modify some factors as non-public firms
tend to be assessed somewhat differently
142
.

3) Tests, Scenario Analysis and I nterviews

Third and last, based on all the aforementioned results and data we will attempt to establish a
selection of different tests, scenarios and interviews. They will showcase key elements we
think will be useful in our analysis and discussion section bringing out the most of our
Master Table:

Support Tests
A) The first part of support tests consists of showcasing different important elements of
the comprehensive Master Table we have developed. For efficiency and time constraints
reasons we will use 1 bar graph and 2 bubble graphs to illustrate most of our key points.
However, please note that there is the possibility of creating tens of different visuals and
other designs. They will showcase a myriad of information and we have chosen to cover
the most important elements only to discuss and analyze the table as whole and not only
spend time on charts.
Create 2 factor focused Bubble chart: where the Y axis will represent for one our D/E
(leverage) ratio and for the other the Debt to EBITDA. Meanwhile the first diagram will
use the EBITDA Margin as the X axis and the second will proceed with the Sales Growth.

140
However, it is important to note, that once the equation is developed 2-3 years averages can be plugged in.
141
Using private data from a reputable company with many suppliers and strong selection processes to ensure
quality data like Total would be a good example and would present a perfect follow up research paper to our
current work.
142
As we have seen in our academic review.

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Finally, the size of each bubble on the map will correspond to the grade of each supplier
from (0 -10) and the type ranking (1-4). It is important to say that different Y and X axis
elements could be chosen to illustrate many information and conclusions. This illustration
will allow us to comment on the positioning by different types and grade of companies
(see how correlated/sensitive higher ranked suppliers tend to be with our 4 variables).
Create an industry wide bar graph: where we will have overall supplier grade on the Y
axis and all the different 50 suppliers, 10 different business sectors (10 year averages) and
the industry wide grade represented on the X axis. This will enable us to have a clear
vision of how each sector performs generally (useful for future benchmarking) or how
safe the different segments usually are. On the contrary, which ones require more
attention and how they fare in general in comparison to the whole industry? It will also
enable us to observe grading trends over the course of the past years to make further
analysis and allow our partners to develop more specific segment oriented studies based
on this format and methodology.
As mentioned previously, to complement the two aforementioned graphs, we will analyze
and discuss the reference table as only support. This time, we will review the differences
between (each companies, suppliers, their sector averages and the industry mean, across
the factors and their averages). Comparing and analyzing these elements across the 10
year time frame will enable us to unravel interesting trends, variations in certain sectors
and companies and specifically pick out major changes to investigate further. For
instances, looking at how each 5 factors have evolved over the 10 years and possible
observable disruptions. Finally the multiple situation averages portray a vast amount of
information, showcasing one of the strengths in our Master Table. Where, the different
norms represent significant cross sectors information, evolutions and conclusions on a
multiple year/variable base. Ultimately, we will review the evolution and variations of the
final outputs over the 10 years (grades, type of rating) to allow us foresight into any
potential indicators of deterioration and signs of disruptions.

B) Perform an analysis per type of companies. Create a small table allowing us to
recapitulate in a clear format what each supplier depending on their ranking (1-4) has in
common. This information will allow us to perform cross checks, cross-analysis,
comparisons and observe the differentiating elements in each grouping. We will also
include the major trends on a factor basis for each supplier ranking and observe key
features such as: How many type 3 suppliers have become type 2 and vice versa, over the
years and what were the determining elements in these switches. Growing on this review
of variations and tendencies we will especially focus on the evolution of each type of
suppliers in order to justify, why type 1 and 2 companies are deemed safe not to go
through a rigorous financial evaluation process and why type 3 and 4 must on the contrary
undergo the further appraisal. By showcasing over our 10 year period that type 1 and 2
suppliers benefit from a stable overall performance in the factors and overall score we
will show the redundancy in performing further financial evaluations on said suppliers.

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Overall this table will be a great showcase enabling us to discuss many elements that
make each type unique, the common group similarities, specifics and understand their
dynamics more clearly.

C) Compare the Master Table overall grades we obtain with other standardized
(technics/scores/ratings). For the purpose of this test we will use a selection of 10
companies, 1 from each of our determined sectors. To help us do so, a small table will be
created grouping 3 other selected evaluation methods
143
with the global score we have
developed. Once this will be done, an average weighted grade of all the combined
methods will be calculated to use as a reference value
144
. This average will enable us to
analyze and observe the different variances of each technique to this mean value and allow
us to judge of their respective volatility and relative efficiency. These variations should not
be understood as wholly proof that a technique is better than another, but it will give us
interpretable information regarding how each of them behave. Finally, this test will enable
us to better grasp the overall accuracy of our model and establish an average grade to be
used in future studies for our partners. Ultimately, for the different conversion rates and
ranges developed for each singular grading method please refer to the Appendix (Practical
Section, Exhibit C N4).

Scenario Case Study

D) The goal is to go through a scenario case of what would happen trying to analyze with
our established process a sample of companies which have gone bankrupt or are in the
process of doing so (Use our compiled 5 bankruptcy supplier/company data).
This type of review and analysis will help us to see if our 2 outputs (equation score and
the ranking + grade) can efficiently categorize and potentially signal these 5 bankrupt
companies (3 years prior to bankruptcy) as danger suppliers. From the gathered
information and the different test observations we will hopefully be able to operate some
minor modifications to the scoring equation enabling us to achieve better results and
ameliorate our working model.

143
Piotroski score, Moodys rating and Altman score whom will all have been transformed to represent a similar
and comparable style of end value.
144
Showcasing the most objective overall grade since based on the mean value of different technics.

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Essentially, the goal is to see if they would be distinguished as type 4 companies and if
not for a 10 year duration when would they turn into type 4 suppliers? Hence we will
try and understand looking at the complete reference table, what elements have caused
the shift from maybe a type 2 or 3 supplier becoming type 4 and presently showing
high concerns of disruptions. These specific changes can be very indicative and allow for
further focused research on a more focused 1 or 2 year basis to find the specific
underlying elements in these outlined signals of bankruptcy. Thus helping the
researcher, look at the right time frame and in the right area, saving considerable time and
giving higher probability of resolving said issues. Moreover, these tools will help in
potentially answering or advising on the question of how far back potential disruptions
can be observed (forecasting a bankruptcy events) and how fast do they tend to occur
145
.
Furthermore, since we know when each bankruptcy has happened we can take a
backward approach and see how the grades, overall score, ranking, factors and averages
have evolved (variations) prior to this date.
Finally, it will showcase the models usefulness not strictly for predicting bankruptcies but
instead warning for the possibilities of such events. In return, allowing companies to
evaluate and review key indicators, at specific times in order to take the precautionary
measures against such future disruption events.

Interview

E) We will conduct an Interview with one professional from the purchasing department
of Total, helping us answer our different research questions. This interview will give us
an experience basis review of our topic and enable us to integrate a strong business focus
to our FMP. Allowing us to finally see if our findings have been coherent with the
industry reality and also hopefully show the usefulness of our study. The set of interview
questions and answers can be found in the Appendix (Practical Section, Exhibit C N2
Interview).

145
Potential further research on this topic: Observing how to adapt current evaluation purposes to take
faster/shorter time frames disruptions into consideration.

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4) Recommended working method and comprehensive process

a) Input a company data through our master table (preferably public for time constraints
reasons, but if the data is readily available it will also work for private companies as our 5
variables/factors do not take market data into account). However for ease of use and
depending on the situation of the data analyzed
146
, our first developed tool (scoring equation)
can help us substitute the table.

b) After the data is inputted in the (Table or Equation) it will give us 2 different outputs:

1) An overall score based on the different data, variables and established weights for
each respective elements.

2) A company grade out of 10, derived from the overall score based on an established
range. Then a subdivision of this grading is observed as a company type rating from
(low risk: 1 to high risk: 4), based on our pre-established 5 most relevant factors of
performance and the consequently developed equation.

c) Moving on, these 2 outputs we have obtained for each desired supplier enable our partners
Total to take decisions on what exactly needs to be done next:

- If our second output (Type of Company + Grade) gives us a supplier ranking of 3 or
4, then the supplier will need to go through to the next stage level of analysis level 1
as we have seen in our previous developed tests. These types of companies are
considered too uncertain and interrogations should be raised about their financial
health. Thus, a detailed tailored financial analysis must be performed to better
understand the underlying issues, assess the situation and see if the supplier is still
viable to work with. However for the purpose of being time efficient and bringing
something new, it would be judicious to assemble the level 0 scores (D&B and
COFACE) and our developed Master Table equation grade to balance the rating.
Thus, depending on a confidentially established (Total decision index) this new rating
will allow them to screen out the top performers of the type 3 suppliers and reduce the
number of overall financial analysis performed per year.

146
If average values have already been calculated or for a single period.

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- On the contrary if our first output gives a supplier ranking of 1 and 2 then there
would be no need to move on to a detailed level 1 analysis. It would be deemed
unnecessary since these suppliers would not be considered at-risk as we have seen in
the test section previously.

However as mentioned before, we expect this tool to show substantial limits as many standard
scoring models have shown earlier. Whether it is in terms of accuracy, impact of outliers,
specific situations or statistical mismatch with business reality. Hence, depending on the next
section where we will discuss, analyze and conclude on our different tests and scenario study,
specific situations will have to be taken into considerations at the key steps of our
developed process.

C) Conclusions

At this level and with this information, our table and the tools developed will have hopefully
efficiently screened, scored and categorized companies into different risk compartments. This
will have helped Total in their decision making process and risk planning procedures.
However, if the scoring shows liabilities then extremely important information will be
gathered on the different limits of these various instruments.
Moreover, depending on our observations, specific precautionary measures for risky suppliers
will have been undertaken, meanwhile safer partners will have been vetted as financially
and operationally sound companies not subject to further financial assessment. This method
will allow to complement and strengthen the already existing Level 0 analysis and could
potentially be implemented as a middle step called Level 0,5 in the overall evaluation
process. It will offer an alternative to the challenged Altman score, the cloudy and externally
dependent D&B or Moodys ratings and the in depth, time consuming level 1 & 2 tailored
analyses.
In return, this research will enable Total to better handle and understand the underlying
financial risks involved with the more risky companies, how to best mitigate possible
disruptions and use this information to their advantage for negotiation purposes, risk
management and other steps in the supplier selection process.
Furthermore the Master Table and its outputs will also work as a warning sign type of
model, especially efficient if further adapted/tailored to specific needs and sectors. The
practical section as a whole will assist the company in having a more thorough financial
evaluation methodology within its supplier selection process.

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Additionally, we think the applicability of the Table and Score extends beyond the observed
outputs. Hence, we believe that by breaking down the model
147
into its individual parts, we
are given a picture of what is creating the financial distress within each companies (if any).
Also, when we chart the results over a couple of years, we are also given a timeline of how
the variables have transformed over time. With these pieces in hand, we are able to assess
how the firm must adjust their capital structure or operating results to continue as a going
concern.
In conclusion the developed working methods in the previous part, will enable its users to
correctly implement step by step the established tools and support tables. Eventually the
different tests, scenario analysis and our professional interview will give substantial insight
and provide an industry wide analysis. Ultimately, giving our partners the potential in terms of
ad-hoc and further focused research/modelling developments of their own.

Chapter 4: Results, Analysis & Discussions

A) Master Table and its inputs

For further illustrations please refer to: Appendix (Practical Section, Exhibit D N1).

With regards to our complete table, it is important to bring to light its great flexibility.
Everything being linked together and automated, the study can easily be expanded in terms of
numbers of companies or years reviewed. This was a worry of ours developing such a table
and study that would not only serve our purpose, but that of future research as well. It is for
that reason in our excel file that another tab Master Table inputs has been implemented in
order to enter all our raw data within this sheet to allow for a clearer display in the main
section.

147
With its carefully selected variables based on previous studies and professional interviews.

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B) The Outputs & I nterpretation Keys

With regard to the outputs, they have all been calculated from the entire data set we have
gathered ourselves for the purpose of this study. Furthermore to maintain accuracy levels as
high as possible we have formatted our Outputs in the same manner as our Table to ensure
coherence of interpretation is maintained.
The first of our different outputs is a score derived from an equation we have calculated. To
determine this equation, we have performed a multiple regression on a dataset including our
10 year sector averages on each of our 5 factors.
These elements acted as our X (dependent) variables, meanwhile in order to retrieve the
different weights assigned to each variable we had to use a (Independent Y variable) as a
score comparison. Considering our topic and previous discussions with professionals in the
sector, we established that the Altman score which uses only financial accounting information
(like our objective score) would be a good proxy mark to use in our multiple regression.

To view the details please refer to Appendix (Practical Section, Exhibit D N2). Here are the
different elements we can observe from running our multiple regression:

- One negative weight, which is a concern since theoretically the variable in consideration
(EBITDA Margin) should be positively correlated with the Altman score (higher margins
= higher scores). As suspected and now tested, the big disparities in margins between
sectors has led to a confusing weight regarding this variable
148
. This is very important
information about the limits of using such factors on an industry wide basis. If we had
focused on a unique segment, then the range of our different variables would have
been on the same scale. Thus, variations would have probably been much more coherent.
- The importance of Sales Growth and Current Ratio as variables in the scoring, is heavily
shown via the big weight values. This does makes sense as revenue and current liability
coverage are both very clear indicators of a firms well-being and less biased / impacted
depending on different business sectors.
- Our statistical P-value is not so relevant. As we can see at 95% confidence level we
cannot reject the null hypothesis that our model is statistically insignificant. However,
like we have mentioned, the importance of the study was to be able to show the limits of
such tools (vs. tailored analyses at level 1 & 2) and allow a better understanding for
further precise research.

148
Our method takes 7 elements into consideration and is quite stable overall to sector differences as it takes
averages into account. However, the variable EBITDA Margin is quite sensitive to these variations as the cost
structure differs significantly within an entire industry made of several segments.

66

- However, this model/methodology fits the objective of this study in creating an industry
wide warning score. Furthermore, it shows us the disparities and difficulties in using
automated models, hence putting forward the different uses for financial analysis. We
showcased the limit in range of such methods, where outliers, scales and industry
benchmarks tend to confuse datasets and lead to clouded information and results.
Likewise, due to the big disparities within the variables depending on the business
segments, it would be wise to possibly develop multiple ranges. They would then be
adapted on a case by case basis. Still, this would all together defeat the purpose of such
tools which is: ease of use, rapidity of implementation and standardization.
- As we observe, no model can be 100% efficient or accurate
149
. Nonetheless, what is
important is understanding its methodology, the process developed and the lessons we
learn to avoid future wrongful analyses. It will lead to better research based on:
segments, industries or product lines that share common financial, operational and
business settings. In turn, helping limit the potential for miss-interpreted data and also
benefit the overall supplier selection process.

This helps us convey our message and goal, to show the importance of human based judgment
and financial analysis. Being able to interpret outliers, adapt the model and read discrepancies
within automated tools is critical. Within a complete evaluation process (level 0 0,5 -1 & 2)
collaboration leads to greater efficiency
150
and better allocation of resources to assess possible
disrupting events.
Moreover, many questions can arise from such developed outputs. For instance, could we
have taken a different variable, focused on a smaller sector range or taken a longer year array.
The probable answer is that a combination of these will yield more accurate results. In turn,
this is the limit of any research, but also the objective to showcase potential for further
interesting examination not imagined beforehand. We did not intend to, as E. Altman and
others have done, accomplish a study with the main goal being to develop a bankruptcy
prediction model. Our score is simply a means to an end, helping us showcase one evaluation
method amongst many and how potential collaborations can be implemented from these study
findings with financial analysis or qualitative reviews.
As we have just portrayed, real limits exist in using such scoring technics. Yet, Altman who
developed his model based on private manufacturers (Z-score) has been the foundation for an
incredible amount of research in scoring technics, hence our previous choice for the
independent factor.

149
It is not portrayed in this work but at 90% confidence levels, accuracy was slightly improved. However this
accuracy situation does require a change within the model itself and not only the statistical parameters.
150
Help reduce the number of tailored financial analysis to only pre-screened high-risk suppliers.

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Our first output (score) now detailed, we can move on to the second one. It consists of using a
Benchmark and Conversion Table, refer to: Appendix (Practical Section, Exhibit C N3) to
transform our overall scores (from the equation) into grades (out of 10) and types of
companies (out of 4). Furthermore, only careful practice and interpretation of these methods
will allow a sound decision making process, hence the fact it was developed with
professionals of Total S.A to ensure its validity.
As we can observe from the table, assuring the range is well established is paramount in the
successful interpretation of the other tools developed
151
. Additionally, in developing this
benchmark and conversion table we have been able to observe the quite substantial
differences that lie within the Oil & Gas industry.
Therefore in the same spirit as before we have calculated for all our outputs a range of 10
years which has really allowed us to best observe the evolution of each one over this
timeframe. Finally, we were able to establish in our future tests different key conclusions
enabling us both to better understand the sector but also appreciate the previous limits we
mentioned using statistical tools.

C) Support tests

Please refer to: Appendix (Practical section, Exhibit D N3-5) which follows the tests order
as well.

Test A Master Table Review

Looking at the 3 different graphs and Master Table we have created, we can observe major
trends and interesting evolutions from our data. Appendix (Practical Section, Exhibit D
N3).

- EBITDA Margin:
First we see in our (Margin vs. Gearing) bubble chart that there is indeed a trend where
companies with higher EBITDA Margins also tend to present lower D/E ratios.

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Should be tailored depending on the dataset if used for other research.

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We observe that industry wise the levels are impressively stable since 2004 (19.7%) and 2013
(21,7%) with a peak of 26,8% in 2007 (pre-crisis). However, intriguingly we can find extreme
outliers in terms of margins where companies like GE, Golar, Ensco or Tenaris clearly
outperform their business sector peers. This tells us that there has been a stable proportional
link between both revenues and costs over the past 10 years in the industry as a whole.
Furthermore, as mentioned previously this variable is highly segment oriented and influenced.
For instance the EPC sector is well known for having very high costs and lower margins of
around 6-8% which would be considered as correct. Meanwhile the indirect cost structure of
the FPSO segment or the less cost intensive RIGS sector show high EBITDA margins (35-
45%) but the scores and grades can tell us a different story. This in turn does make it difficult
to interpret the industry as a whole with this factor since so many unique functions and
business segments are present.
However, EBITDA Margin is a very important/vital variable to take into consideration
meanwhile assessing the financial situation of a company. We have noticed after our data
analysis that clear and tailored benchmarking helps make stronger and more accurate
interpretation of these numbers. Since, the correlation between this variable and the Z-score is
negative, to some extent the image we have of high level margin companies is distorted. For
instance, Petroleum Geo-services is a great example of the limits this model presents and the
need to adjust this element manually (change interpretation / adjust weights / change dataset
/ cap certain numbers). However this does not mean in most cases the model is wrong, on the
contrary, if we look at Petro China the company has very high EBITDA Margins and still
portrays a grade of 9/10. What it does though, is struggles to score correctly more financially
subtle (appear average but are actually quite strong) companies.
Finally, when we take into consideration this singular boundary in our model, it is easy to
adapt for it. After discussions with Total, they will try to: use an extensive benchmarking file
for this factor they have developing and also use a longer/broader dataset to try and flatten
variations. Ultimately, the score serves mostly as a categorization tool helping us decide
whether or not more resources should be spent on reviewing and financially assessing the
supplier.

- D/E (leverage) ratio:
Moving on, we see that the majority of analyzed suppliers have gearing ratios falling between
(0,5 and 2) which gives a good idea of general leverage levels in the oil & gas industry, but
also of the significant equity ceilings. However it is worthy to note certain exceptions in terms
of segments where for instances (FPSO, Support Vessels and Rotating equipment) are few
areas with known and observed intensive asset usage as well as higher debt echelons.
Looking at our bubble graph the negative correlation between EBITDA Margins and
Leverage ratio is easily observable. Where, higher EBITDA Margins (although not capturing
debt elements such as interests) are linked with lower D/E percentages.

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Additionally, we cannot stress enough the importance of this ratio as many times it has been
observed with bankrupt companies that equity volatility is a great indicator of financial
distress (as we will see in our scenario analysis). Another extremely important argument from
the chart is how we notice most companies are both under the industry average on both
element scales (D/E and EBITDA Margin). This shows us the importance that outliers have
played in our overall dataset, and why analyzing the different figures using such charts, tables
and 10 year arrays is very efficient in interpreting details that general statistics may sift
through.
Moreover, on an industry level the factor has been quite stable over the 10 year range (1.48-
2.51). This is important to mention since the D/E ratio is often used by investors and analysts
within their company reviews to observe capital structure, strategy and financing. This is why,
public companies tend to place a big amounts of attention in maintaining debt levels in
coherence with their image objectives and in reason with their equity holdings.

- Sales Growth:
With regards once more to our second bubble chart, here too, we notice a significant trend
where higher growth companies usual have lower Debt margins. This can be explained by the
fact that strong revenues usually enable stronger EBITDA levels to help cover the debt and its
interests.
As for the industry benchmark it stands at 13% growth, showing the drive this industry has
sustained over an average 10 year period. However, this number needs to be put in context as
levels have greatly varied from one year to another from a +29% sales growth year in 2006 to
a 12% in 2009 post crisis. Here again this factor tends to be higher for some segments like
Oil & Gas equipments as well as Rigs showing strong growth numbers up to +45% excluding
2009. As a whole, Sales Growth is less segment oriented / impacted then EBITDA Margin and
appears to be a more logical element for business comparisons and this type of research.
However, the factor, at industry level has evolved in two folds over the course of the 10 years.
Pre 2009 growth numbers were good and averaged above 20% annually, however after a
sharp decrease in 2009 and recovery after, 2013 has seen stagnating levels at a mere +1%.
Most sectors have shown very inconsistent averages such as Rotating Equipment, OCTG or
Seismic Acquisition, where the fluctuating and cyclical revenues have been substantially
impacted by the different global turmoil. This disparity can even be observed at sector level,
where direct competitors showcase very different growth levels. If we take for instance
Dawson Geophysical with a 62% increase, meanwhile Ion Geophysical had only a mere 2%
rise. Finally, we notice these variations are commonly observed across the entire sample, not
only with certain outliers, which does support our findings that this factor is representative.

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- Debt Margin:
First we notice that the levels are quite high for this industry and that they tend to be quite
stable apart for some major outliers. For example Ebara Corp. in 2005, TransOcean in 2012 or
IonGeophysical in 2009, which have all impacted their sector averages relatively importantly.
Moreover, we do notice some trends within different business segments, where General Oil
integrated companies usually show the lowest Debt Margin levels thanks to high EBITDA
levels since they do tend to also have substantial debt from fronting many project costs.
Whereas Support Vessels observe some of the highest margins due to their obligations in
buying/renewing major assets with debt.
Furthermore, the factor has evolved quite stably at a global industry level over the course of
the 10 years showing peaks in 2009 (post financial crisis) at 10.08X due to some major
increases in debt costs and lower revenue figures for most companies.
Additionally, this variable shows us the amount of years it would take for a firm to repay its
entire debt/liabilities using its EBITDA as the resource. Hence, we observed it was standard
that in this asset heavy and high leverage oil & gas industry ratios were relatively higher than
in other industries. As previously mentioned through our bubble chart, high growth companies
tend present lower Debt margin ceilings with most of them under 5X (5 years to repay debt).
This showcases strong coverage of liabilities and financial obligations.
Finally, the correlation between the Z-score and this ratio is somewhat complex as higher debt
levels and lower EBITDA would normally signify worst-off companies. However, we noticed
that it could also be interpreted as companies trying to invest (raising debt), where the
EBITDA levels would have not yet increased. Therefore, we wish to put forward the
importance for careful assumptions, analyses and examining this factor on a multi-year scale.
If we talk about Rolls Royce in 2010 and Wood group 2011 they are great examples of such
growth strategies (return to higher sales growth following years of high DEBT Margin levels).
Of course this is not always the case and most of the time higher ratios are not good (financial
strength / strong management) signs. However, it is worthy to point out the limits of such
variables and the overall objectives of our model (Assistance and Warning tool only).

- Current Ratio:
This ratio has unsurprisingly been the most stable one industry wide over our 10 year array
moving from (1,82 to 2,20 only !). Furthermore a key element of this variable is its much
broader unity over the sectors. Besides General Oil Integrated Companies with very high
levels of both long term and current assets
152
or FPSO & Support Vessels with the lowest
sector average, most of them are between 1.25 and 2.25. This stability and logic is also
portrayed through the strongest coefficient (% wise) with the Z score.

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Such as stocks or shares, since they have their hands on many projects.

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Where, sturdier grades link clearly with higher current ratios (despite extremes, where, very
high level of assets can suggest miss-usage and raise certain efficiency concerns).
Hence, we almost unanimously observe top ranked and high grade companies to also show
strong current ratios, thus strong short term liability coverage which is one of the most
important elements for sound financial management but also in forecasting liquidity issues
and future disruptive events.

- Altman Z- Score:
In general we observe good correlation between our model and the Altman Score as testified
with our multiple regression R of nearly 80%. However, the Z-score has been developed
using a much wider sample of companies
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then our study and has also examined bankrupt
company data within the sample for establishing the different weights. Still, its findings and
results are like ours: questionable in their judgment. Take for example known stable
companies like Technip, GE or Subsea 7 who, despite being well rated (investor, analysts,
brokers) showcase many times, scores considered to be in the Danger of Bankruptcy zone.
Furthermore, like our model the Altman score varies widely from one year to another. Where
a company such as Foster wheeler showcasing a Z-score of 0,06 in 2004 will present 3 years
later in 2007 a new score of 4,55. This does highlight the limits in using such technics as
prediction tools. Hence our suggestion for adapting them to business sector specific elements
and also reconfiguring their uses as warning models instead of predicting ones. As we know
accuracy and risk management is less of an issue while cautioning rather than predicting.

- Score, Grades & Ranking:
Looking at our two bubble charts we do get a mixed image regarding grades and specific links
to certain variables. The EBITDA Margin as mentioned is not well correlated and this can be
observed with the biggest bubble mostly present at middle EBITDA Margin levels. There
does seem to be other things in play at this level (credit standings to name one).
Meanwhile, as attested by the weight given to sales growth, the score is well correlated with
increasing revenue levels. The higher ranked companies tend to show for the most part high
growth levels, apart for some rare exceptions, proving a good indicator of activity progress.
Now if we check the Grade overview bar graph created, we observe an oil & gas industry
wide grade of 7, which makes a lot of sense when considering the different elements in play
in this industry (high debt levels, good sales growth, strong asset positions and strongly
covered liability positions).

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Taking into consideration and accounting for all subsequent studies which perfected the concept and model.

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Furthermore, this illustration gives us a clear picture of which sectors perform well according
to the model, like: Seismic Acquisition, General Integrated Oil Companies or Oil & Gas
Field Equipment. It also shows us specifically some of the outliers in terms of grading such
as Ebara Corp. who when analyzed more closely has been heavily impacted by very poor
EBITDA levels in 2008 which disturbs its overall rating and score.
This is why we need to mention that, simply observing our table it is difficult to identify
meaningful indicators of possible disruptions. The data does present some strong variations
from year to year either from the variables or the score itself. Take for example Mitsui which
has changes type in each of its last 3 operating years. However for certain other firms the
data is easier to interpret as with Petroleum Geo-Services which has been showing signs of
weaknesses quite regularly over the past 10 years. This situation is a great example of a strong
indicator to perform additional financial assessments on said supplier.
Furthermore if we observe the outliers in general (very high or very low scores) it is important
for us to mention that several traits emanate. Take Golar for instance who presents a negative
score. It is essentially due to the fact that it presents huge EBITDA margins (negatively
correlated) low but decent growth, a good current ratio but high Debt levels. This
combination, with our equation gives it a very low score. Thus, this company will be carried
and analyzed at the next stage (level 1) in the financial assessment process. After, more in in
depth review and further details obtained it will probably qualified, since the elements are not
alarming. This brings us back to the limits of models in general, but, once we account for this
issue and understand the underlying elements we can accordingly adapt to the environment.
On the other hand of the scope a company like Cameron shows a grade of 10 because it has
all strong variables, despite somewhat high debt margin levels. This, in turn, shows us the
ability of our model to act not as estimate tool but more as a categorization model of sorts.

Test B Type Review Table

Please refer to the Appendix (Practical section, Exhibit D N4) which is a review table of
the different Types of suppliers and their main features.
When we look at the Type Ranking Table and outputs, we see that it is very hard to
efficiently predict disruptive events. Some suppliers such as CGG, Foster wheeler or
Dawson Geo have an overall ranking type 1 or 2 but still have proved as of late 2011-2013 to
not be as financially sound. Thus, caution must be undertaken when we look at 10 year
average scores as they tend to dilute big variations (which can reveal a lot as well).
However, for the purpose of our research, averages are both essential (regression) and very
useful as they enable us to make overall sector and industry wide conclusions on a decade
range. Nevertheless, for business purposes, the timing and timeframes are different.
Everything moves faster and bankruptcies can happen very quickly.

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Hence, our advice to Total is to use our model as advertised (categorization and warning tool),
to inform them on the type of supplier they are dealing with, so they can easily decide on the
different measures to put in place.
We believe the 2 key elements in our model for type 1 and 2 supplier are strong sales growth
levels and stable and high current ratio, hence good short term liability coverage. As for type
3 and 4 suppliers the most common and harmful factor is high debt levels or as we will see
with some highly disruptive firms, negative equity. Moreover we observe the most changes
between type 2 and 3 suppliers where at one point minimum in the 10 year range they have
interchanged.
Furthermore, we notice that the main key elements in the switch from a safe supplier to a
risky one is usually, growing debt levels combined with a slowing of the activity (Sales
growth and EBITDA numbers decreasing), where the perfect example of this has been
Diamond Offshore Drilling.
Finally, what enables us to justify the safety of Type 1 and 2 suppliers is the fact that they are
strong in most of their variables. Furthermore, to obtain an average rating so high, they must
have shown substantial resistance and overall stability to remain financially sound suppliers
over 10 years. Even If they have not always been Type 1 and 2, the fact that their resistance
and overall average score categorized them as such (Type 1 & 2). This gives them the security
qualification our partners Total look for while assessing their potential partners.
On top of this, the relative ease, speed and simplicity to tailor this process enables our partner
to perform checks in regular intervals, which is not the case with level 1 financial analysis
which are almost always performed on a yearly basis.
However, type 3 and 4 companies, whilst not all terribly risky suppliers, they showcase some
cautionary signs of possible disruptions. Hence, these are the target groups for future more in
depth analysis at levels 1 and 2 in the established working process.
On top of that, some of the type 4 companies have been considered as outliers since they
present very low scores but mostly due to a bad and miss-leading combination of (very high
EBITDA Margin coupled to the negative weight), (very low sales growth) and relatively high
debt. We have seen by observing our partners Level 1 analysis of these companies that most
of them were qualified due to the fact that they were most of times well established
companies. The low growth was the product of their life cycle, strong margins is a good
element and high debt in these cases shows investment and their ease of access to capital.
Ultimately, this test showcases the limits with singular situations and our model and other
statistical tools in general, which cannot take into consideration such advanced interpretations.

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Test C Scoring Comparison Table

Looking at our comparative recap grading table we can see in simple terms how valid our
technic is based on an average variation to the mean basis. Please refer to Appendix (Practical
section, Exhibit D N5) which is review table of the different Grades of suppliers and
their adapted scores from other techniques.
First off, we notice that the 10 company-wide overall variations vary from -3,1% up to 3,2%
which is quite a broad range. This in turn tells us what we have been trying to confirm that
statistical assessment methods are not the most accurate tools at our disposal. However,
understanding the key elements driving each different method is probably more important
than observing the grades or initial scores themselves.
For instance we notice that the two best average variations are obtained from our model (-
0.2%) and Moodys credit rating transformation (+0.1%). Yet, one technic is achieved using a
lot of different information and takes considerable time and resources to be operational (paid
accounts, understanding of the entire firm process, time to replicate, external resources,
complex data and information, etc.). Meanwhile, our method despite slightly more volatile
(based on this simple variation measure) performs admirably, even better than the Altman or
Piotroski models.
However, the most interesting aspect is the overall (based on 10 firms) negative variation
observed in our score. It shows a tendency for our model to give a slight pessimist assessment
of the evaluated suppliers. This is what we want to achieve when taking into consideration our
supplier selection mindset and disruption risk management objectives for this research.
Additionally, we must mention that these score were obtained with our limited yet slightly
altered model
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used for the purpose of this initial ground research. Taking this parameters
into consideration, we observe the two most significant variations of our method to be related
to the companies Exxon which obtained a score of 4/10 and GE with its 3/10. Nevertheless,
we know all things considered when we factor in qualitative factors, entity specifics, segment
benchmarks, and human judgment that these firms are not at risk.
Hence, this tells us that our model does have like previously mentioned its own limits. For
example we know it does have a strong credit analysis feel to it as with Moodys rating and
the negative weight of our first variable. But, when we account for these particularities and
adjust for the negative coefficient, the two companies find themselves to not be risky after all.
In that sense our model will only miss-rank (if not adjusted) suppliers in a negative way
which will lead potentially to their pursuit at a level 1 analysis for further review (where the
full financial analysis will be conducted highlighting the past uncertainties).

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For accuracy purposes, we did operate 2 of our 3 changes (from Scenario Analysis) onto the excel model.

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However, as we will show in our scenario analysis with highly disruptive suppliers it will not
miss-evaluate risky firms by ranking them too high
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.
When these 2 specific cases are taken into consideration we see that the grading for the other
companies is rather spot on. Letting us believe that adapted to specific situations within the
evaluation process we developed, good warning results will be achieved by our partner
company.
Additionally, something very interesting is the different features of each type of grading or
scoring technics. Some are based more on credit metrics while other focus more on operations
and efficiency ratios. Taking this into consideration, it would prove to be very efficient if the
average score we have obtained from the combined 4 methods could in some way be
molded into a new more efficient and objective grading tool
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.
That way, the composite technique would take in reflection a larger number of elements and
account for different features covering the financial assessment of potential suppliers.
Finally, the tools we have worked with are all well-known technics. Despite being somewhat
restricted and criticized they are still widely accepted and commonly used tools in a business
setting and have been the foundation for many other research. Hence, when we compare our
scoring model and see that it performs rather well despite using few and simply retrievable
information, this shows us the possibility for quick models to be developed. Ultimately, some
adjustments and the use of different tools combined together still remains the most complete
and risk cautious processes.

D) Scenario Analysis

Please refer to: Appendix (Practical section, Exhibit D N6) which contains our
comprehensive bankruptcy data, news and full scenario case study.

First, the real important element about this scenario case is that it enables us to trial test our
model versus companies who have suffered major disruption events. Which is not the case nor
the objective of the first part
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of our research.

155
These better results are achieved by operating a third small modification to our model and excel formula. This
alteration has only been implemented in the Scenario Case Study otherwise called Second Part.
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Great potential for further fascinating research here.
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First Part: Before the Scenario analysis, prior to testing the model against Bankrupt / Disruptive suppliers.

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Hence, taking into consideration the different observations of this table and the previously
mentioned weaknesses of our model, we are able to make some changes and attempt to obtain
a more accurate and efficient scoring tool. For this reason and after our clarifications we have
made 3 different changes:

- If EBITDA Margin is negative then the value of the variable becomes 0. This was done
to mitigate the potential faulty effects of having big negative margins multiplied by a
negative ratio, hence increasing the score (illusion of good score, despite bad results).
- If Debt/ Equity ratio is negative then the value of the variable becomes 0. Same principle
and methodology followed as above. Since negative equity is a very alarming sign of
possible disruptions and now it is correctly accounted for with the model.
- The last change we commanded, which is accounted for in the (Scenario Case Study) is
the ceiling added to the last variable Debt Margin. We noticed that every item was well
covered with this factor
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apart from situations where the ratio would reach too high
values. In this sense we observed and agreed with our Partners that a ratio of above 12.5
was the limit to not surpass (can be changed according to risk aversion levels of the
evaluators and sector specifics). Thus, if the ratio exceeds this value, then it will
automatically take the value of 12.5, in turn capping this variable. We have also
suggested such other modifications for EBITDA Margins, to help with the automatic
interpretation issue and they will evaluate this possibility in future investigations.

With these operated changes, the high risk suppliers are still quite successfully identified and
the only remaining limit of the model will be with suppliers showing high EBITDA margin
levels, puzzling the score and making it lower then should be. However, it is very easy, when
high data values are observed to take this factor into consideration and adapt the decision,
benchmark and process accordingly on a situation specific basis (as we suggested to Total).
The most important element however is to recognize the room for continuous improvement
and also flexibility with the model. The key part is the process and methodology of
development, then adjustments can be operated to make the equation more accurate, tailored
or factor focused. We were able to recognize the limits of our statistical research and this is
extremely important for the learning process, especially within developing statistical scores as
it helps improve end results.

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If the Debt Margin is negative which is bad, then it decreases the score which is normal. If the Debt margin is
low which is also good then the impact on the ratio is minimal and wont work against the end score. Moreover
the higher the ratio the higher the impact on the overall score. This is an acceptable variation up to a certain point
where there is a need to instate a ceiling to limit the increase in the score and false image of good results.

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Moving on, we see looking at the different evaluations obtained that in 100% of the analyzed
cases and in all years the model has been efficient in identifying and categorizing these
unsettled suppliers. All these companies have been Type 4 up to 3 years before their
disruption events, apart from Global Geophysical Services who 3 years prior to its Chapter 11
filing, rightfully exhibited strong values (changed radically the next year). This does shows us
2 key elements:

1) There is a tendency for risky suppliers to show signs of weaknesses and past
disruptions who can be warning flags for evaluators and firms alike.
2) In specific cases, bankruptcies can happen very fast, in the space of 2 or 1 year and
even 6 months in some rare occurrences
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.

However, we can observe some simple indicators using our scenario case of red-zone
notices to reveal major concerns. For instances, the sales growth becoming negative such as
Alvarion in 2010, a huge drop in EBITDA Margin like Daebong in 2011 or negative D/E ratio
as of 2011 for Geokinetics. Additionally, we notice all these factors influence dramatically the
overall scoring. For these suppliers it is mostly about suspicious activity and poor long term
liability coverage than anything else. Moreover, we also distinguish the gradual decrease for
all situations of the current ratio the closer it gets to the disruption event.
These specific changes can be very indicative and allow for further focused research on a 6
months, 1 or 2 year basis to find the specific underlying elements in these outlined signals
of disruptive situations. Hence, it will help our partners future research, analyzing the correct
time frame and looking within the exact data area, saving considerable time and giving higher
probability of resolving said issues.
Furthermore, the supplier Geophysical Services is a perfect example showcasing the limits yet
strengths of our model. We see that it couples the high EBITDA margins, hence tells us to be
carefully reviewing the end score and later on adds a very high DEBT Margin. Despite these
results and some minor variations in the overall grade, the picture is still coherent, since it
does categorize it as a risky supplier. If this extreme case, featuring both the limits of our
model, still tells us to worry about this supplier and requires it to go through the more
rigorous level 1 and 2 methods of our complete process, then we can consider our
objectives as achieved even with a slightly flawed model. This does portray very well the
crucial aspects of understanding the method of our technic and adapting for it accordingly.
Ultimately, at this point of reflection our developed score is strong enough to be applied as
a mid-level warning technic
160
within Totals full operational evaluation process.

159
Total will explore this topic based on our research to establish the ideal evaluation time frame & scale.
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However, do to the nature of our research (not a statistical study or bankruptcy model development), better
results could be achieved performing unique detailed and broader investigations with this first-generation
model to enhance accuracy, meaning and correct potential limits.

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E) I nterview

Please refer to Appendix (Practical Section, Exhibit C N3)

Our interview has truly helped us better understand the professional environment and
operating practices of the industry. The questions we asked link perfectly with our main
research interrogations, which enabled us to make strong comparisons and interpret our
different practical findings efficiently. It also helped us establish a link between the
knowledge of a sector professional, our practical support tests and different studies.
First of all, as expected we noticed similarities between the academic foundations and
business methods used to evaluate suppliers and the selection process. However, it is this
methodology, practical tools, flexibility and adaptation to current situations that make the
business world very different from research. For the later, as mentioned by our interviewee,
the focus is on a fix time periods and is almost always backward looking in its analysis
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.
Moreover, no research can be done on a present time basis, which is essentially how the
commercial environment operates, constantly changing and adapting to the new elements in
play, which is something studies and investigations take much time to integrate.
Therefore, there seems to always be some sorts of disconnection between the two, despite
several fundamental theories have been very useful withstanding this time issue. Furthermore
our partners have warned us about the treachery of the Oil& Gas industry. Where, many non-
financial elements come into play which cannot always be clearly interpreted, hence there
occasional needs for external reviews coming from credit agencies or risk management firms.
Moreover, they raised the issue of segment diversity within this industry which could lead to
potential misinterpretation of data
162
and therefore we agreed with Total that a statistical
industry wide study would probably raise many concerns (volatility, outliers, range
differences, benchmarking, and lack of accuracy in existing scores for reference). However,
after much discussions we agreed with them regarding the goals of this research which have
been twofold:
On one hand, to portray the different inefficiencies/strengths between technics or methods and
allow a better understanding of the current tools available and their possible uses together
within a complete process. Secondly, to assess the overall financial situation of the industry
helping them better assess the financial environment. Build on this initial foundation paper
regarding the role of financial evaluation in the supply chain.

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Forecasting does focus on future but is very questionable in the sense that projecting (predictions based on a
set of assumptions) is highly uncertain. If used in parallel to sometimes inaccurate technics it would show a clear
double liability to the research in terms of credibility.
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For instance EBITDA margins vary widely between sectors, but it is a crucial variable to consider.

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Furthermore, the interview has helped us in: certifying the quality of our work (checked by
professionals of procurement, supply chain and corporate finance departments), clarifying our
observations and also in establishing a strong methodology of work. Such as, selecting our
variables (dependent and independent), the right data and within the appropriate time frame.
Additionally, our interviewee answered our question regarding how they dealt with past issues
and disruptive events, which helped us in developing our approach, the tests and the model to
help deal with future disruptions in whichever form they may present themselves.
Finally, as mentioned throughout our investigations and tests it is important to recognize both
the importance but also the limits of financial evaluation within the supplier selection process.
Conclusions of the practical section
Our applied research has helped us raise awareness about the importance of financial
evaluation and the role it plays in the supplier selection process.
These examinations enabled us to conclude on the difficulty to capture financial soundness at
an industry wide level through an automated model. The data often evidenced to be highly
sector influenced
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which at times proved to be confusing and lead to general miss-readings.
It is the lack of flexibility shown from statistical technics
164
which highlighted the importance
of human interpretation and information gathering in assessing the financial health of a
supplier. In turn, emphasizing the significant role financial analysis played within this process.
However, we have also underlined that it can be time consuming to develop a sector or
business specific model for every unique scenario and situation. Hence, with the right use and
limited expectations from these technics they can be great warning tools or provision tests but
should in no way be relied on as pure decision metrics. Essentially, assessing the uncertainty
is key and recognizing the need for further review via tailored financial evaluation helps
develop a stronger process. This collaboration of techniques is best to achieve optimal
efficiency, result and mitigate the weaknesses of each methods.
We must also remember the setting of our research (Contract & Procurement and the supplier
selection process), where the financial evaluation of potential partners is viewed as either a
comparative or risk mitigation tool.
For instances: take two equally strong technical suppliers, both are reviewed and the financial
assessment process will be the last decisive factor in choosing the optimal partner. However, a
more challenging objective of this procedure is to help mitigate disruptions by identifying at-
risk suppliers early on and assessing their capacity to contract with our partners Total S.A.

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Different scales of value, benchmarks and sector specific features.
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At least using statistical technics that were comprehensive enough to be replicated later in further studies. As
we agreed with Total S.A that too complex methods would lead to confusion and miss-use of such tools.

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As we have come to learn, not every situation will require the same type of suppliers,
operational features or even present the same type of freedom of action for the contractor
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.
This is why, we have insisted on showcasing the importance of a thorough method, based on a
multi-step and flexible approach enabling our partners for instance to use various tools
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for
different situations.
Moreover, our tests have shown that if the company financials are misleading or incorrect,
then like many other models our score will probably as well. It is important to remember that
changes in a company's score are as important, if not more significant, than the rating itself.
This is why our study took place on a 10 year range to take into consideration diverse
variations and give further width to our analysis. After all, knowing a company is heading
down the wrong path is better than learning about it after the fact.
Finally, within our practical section we used the different Data, Tables and Tests to support
our two main goals. The first we achieved was to enhance Totals financial assessment process
using different tools and second showcase the growing significance of financial analysis and
risk management within supplier selection.

Chapter 5: Conclusion and Recommendations

Theoretical and Managerial implications

1) Theoretical Implications

Our research has been able to both contribute in complementing and challenging existing
literature in the field of Financial Evaluation and the Supplier Selection Process.

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A typical delicate situation would be a type 3 or 4 company, who presents difficulties financially due to non-
forecasted events but offers unmatched technical capabilities. With careful considerations and in depth analysis
maybe this supplier in the short term only presents average risks and considering the bargain and technical
dependency, the contractor may not have a choice but to contract with them.
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Level (0 0,5 1 2), working their way through the whole process. We have also given some
recommendations in order to better their current process, methodology and precision using current tools.

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As we explored our topic we were able to create a comprehensive academic review of these
different subjects linking both finance and supply chain management. This area of focus has
not been directly explored in the past
167
, somewhat overlooked for more traditional elements
such as operational, legal and technical features as decision factors in supply chain
management.
Our work has really contributed to a better understanding of the key role financial evaluation
plays in selecting, assessing and qualifying suppliers. It has brought a unique financial
emphasis to this area of supply chain management which previously heavily focused on more
operational concerns. Additionally, supplier selection has often been addressed solely as a
procurement issue, without significantly taking into consideration financial reviews as more
than mere complementary analysis. However our academic review and study have showed us
specifically in the Oil & Gas sector that many key financial aspects could tilt the balance
either way very rapidly. Moreover, credit and liquidity factors as well as risk management
have become center elements of concerns in most project feasibility and survival assessments.
In addition, this FMP has also helped the literature get richer in terms of cross-focus within
the Oil & Gas industry, where the financial/supplier selection literature is very meager and
focuses more on general supply chain issues and or operational/technical issues.
When we observe the past literature we can see investigations regarding the singular roles of
these two topics but never has financial evaluation and more precisely financial analysis been
reviewed within the supplier selection process. However looking at todays increasingly
unstable and risky environment, the importance of carefully selecting suppliers using the right
financial assessment tools and methods is more than ever at the heart of many supply chain
management strategies.
Furthermore, we have really tried to challenge the existing theory in the sense that it has
proved to be very unilateral in its focus. Hence, we worked hard on showcasing the
importance of financial and ratio analysis, a method which has highly been criticized in the
recent research and also showing the different limits and advantages of using automated
statistical models to financially assess suppliers. Researching and reviewing the existing
literature but this time in a cross reference manner, we have been able to observe the true
benefits of combining different financial evaluation technics. Understanding the limits has
helped us develop comprehensive process in order to best select suppliers and mitigate risk.
Past studies have focused on highlighting the different weaknesses of the various evaluation
technics. Instead, our FMP focused on showcasing what we learned from such issues and
what were the different possibilities to solve them. Where, an association of different methods
would help bring out the advantages of each one and help mitigate the unique downsides and
lower the overall risk. For instance, ratio analysis and its subjectivity would be complemented
with the objective scoring tools and put in parallel to wide breath rating models for a global
credit overview of suppliers.

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Showcasing the role and importance of financial evaluation.

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Ultimately, we believe our research has helped raise awareness towards a neglected aspect of
supply chain management research who has focused in the past almost singularly on
operational risks and business aspects rather than the significance of financial supplier health
and its broader consequences.

2) Managerial Implications

Since this study mainly focused on real world aspects, the results have very important
implications and we have been able to enhance the understanding of different players in the
field such as: purchasing managers, financial analysts and our partner firm Total S.A.
First we have offered guidelines, suggestions, and recommendations to enhance our partners
financial evaluation working process. They have been reviewed and very well accepted with
Total S.A and thus implemented into a concrete methodology that they are now beginning to
use.
Second, our practical section has highlighted the potential and limits of automated tools
previously used before. This helped us establish a collaborative warning model and create a
comprehensive study table for an industry wide analysis based on multiple factors. These
different findings will enable managers to understand all the evaluation instruments at their
disposal and better grasp the different features in play. Likewise, it will help review the most
influential elements of the past 10 years within the Oil & Gas industry.
However, the real managerial problem we focused on solving was similar to our academic
concern of putting to light a topic many people ignored. Often players within the involved
departments thought of financial evaluation as a simple tool (yes or no decision matrix) within
a more complete process. They misjudged the importance it played within the final decision
of selecting a supplier. We learned that this was due to the highly technical and operational
oriented nature of the Oil & Gas industry.
Moving on, the recent financial troubles for a couple of Totals suppliers and their competitors
within the industry have been the perfect launching platform for our study. Where, our
scenario analysis has showcased the possible uses and needs for warning contractors against
such disruptive events. Additionally, this has been done in a simple way that everyone can
understand and not waste time on. This process, research and consciousness, will enable to
handle future disruptions fast, spot them relatively long before they happen and put in place
the right mitigation/management technics to limit exposure.
Moreover, what we advise managers based on our practical findings is to implement multi-
stages assessment processes like we have for Total S.A. These, developed guidelines and
practical tests have helped in terms of how to address the problems in question. Where,
depending on each case scenario a corresponding solution and a specific path to follow exists.

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The methodology ranges from level 0 to 2, taking into consideration every specific concerns
undetected at the previous stages. For each singular step, several mixes of adapted tools can
be implemented, decisions taken and results observed. All of which help the supplier selection
move forward and always guarantee a multi-level type of control. Hence, the importance to
never downplay the role financial evaluation carries within selecting sound suppliers. Always
using the right mix of instruments, in the right situation and with the right timing.
Finally, the evolution of procedures based on acquired experiences, knowledge of the different
limits regarding the different technics is how processes gradually become more efficient.
Ultimately, raising the awareness of all the people in the C&P Department will come a long
way in smoothly implementing this working process. All the while, making sure the risk
management aspects of the supplier selection are best understood by the majority, since
choosing collaborators is after all the work of many different types of professionals.

Limitations / Further research

1) Theoretical limitations

We have found that these potential limitations have not been our main worry in the sense that
our topic is more practical than it is academic. Additionally, despite the innovation in our
focus, the research does cover well documented and established individual subjects. Hence,
the academic information available
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is more than abundant which has helped us cover the
themes widely and allow us to make interesting conclusions. Which, combined with the help
of professionals at Total, their academic resources and most of all extensive knowledge of
both areas, have really helped us cover the issue in a thorough manner.
However, we did observe some limits, mostly in terms of joint references or linking
conclusions to grow on. These, did hinder the range of cross-conclusions we were able to
establish and required us to conduct additional theoretical research. Which, sometimes had to
be extrapolated from business oriented observations. Additionally, we took the opportunity to
sit down with various sector professionals for more insight into some of the segment
foundations they were accustomed with, in order to cross-check all gathered information.
Finally, as most initiating papers, the unique and detailed academic research/data has been
hard to find, due to the poor coverage regarding this connecting topic. We did observe the
subject to not be regarded as a key decisive element of the overall process, hence its
undeveloped presence within supply chain management literature.

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Financial Evaluation & Supplier Selection research.

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Ultimately, our FMP could have greatly benefited from a global reference source solely
based on reviewing the literature developed on financial evaluation, supplier selection and
financial risk management within the supply chain.

2) Limitations of our methodology (general & practical)

This methodology does have its limit like any other. Having attempted such a large review
both academic and practical has had for consequence to maybe enlarge the topic rather than
focus it. However, the goal of this research has always been to be the stepping stone to future
research and indeed be a general review of how important financial analysis could be within
the supplier selection process.
The approach chosen does to some extent fail to grasp all the small subtleties between the
different evaluation techniques and the various multiple sectors. But, this is expected with our
viewpoint and our shortcomings are only future research possibilities. This is the goal of our
FMP, to shed light on elements without having the presumption to solve all the implied issues
and be the starting point for future detailed oriented research. The established methodology
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despite its few deficiencies does fit best our objectives and allows us to answer our different
research questions. Likewise, developing a full working process via a comprehensive data
analysis, support tests and scenario case study has enabled us to efficiently convey our
message and solve our various interrogations. Additionally, as previously mentioned, the
shortcomings
170
of our topic rather come from its practical section and not the academic
review, which lends itself quite well to the subject at hand.
For instance, we observe from our developed Master Table that there are some disparities
within the industry and the different segments that represent it. Hence, sector specific models,
statistical tests and analysis would benefit from less data disparity in terms of precision and
volatility. However, what is great despite the limits in accuracy, is our model flexibility and
the methodology developed. None of the fundamentals need to be changed in further studies.
It is suggested to rather grow on the equation we created, adapt it for any needed sector and
then tailor it according to specific research as we have done for the Oil & Gas industry.
Nevertheless, in the spirit of development, we recognize applied limits exist. The fact is that
we could have for objectivity and precision of data issues, used a wider range of companies
and a longer timer array. A series of 20 to 25 years, using a 6 month time frame could have
been arranged for depth of research. Moreover a panel of 250 to 500 companies would have
enabled us to cover more types of companies. In the process, helping us to better represent the

169
Based on the comparison of: The findings from a comprehensive academic review vs. A series of real world
support tests and case studies. With the objective to analyse and connect both world to discover new elements.
170
Shortcomings meaning things that can be improved via further research. As the academic review does not
lend itself to a much different work, however the empirical research can be developed in many different ways.

85

entire supplier population meanwhile accounting for different unique situations. All of this
would have allowed the existing outliers within the dataset to be less impactful on the various
calculations and outputs obtained.
However, for time motives and the objectives of our research
171
, the processes and concepts
developed are of far more importance than achieving absolute data precision, which would
ultimately have resulted in shortcomings elsewhere.
Finally, our statistical method, despite being precise could have been enhanced with more
accurate software and advanced statistical instruments. Nonetheless, as mentioned, our focus
is on methodology and establishing a working process rather than having an all-powerful
bankruptcy prediction model, which we will suggest to develop in further research.

3) Suggestion for future research and application

Taking into consideration all the elements put forward in this analysis. We have mentioned the
true nature of our paper, to initiate interest for this topic and layout the foundations of which
role financial evaluation plays within supplier selection.
However, it would of great interest to go some steps further. For instance being able to
quantify the impact of various specific risk factors (financial, legal, operational, commercial,
etc.) on each sectors within our global industry. This would significantly help understand the
multitude of elements in play unique to each segment and thus allow great possibilities of
tailoring in terms of financial assessment instruments.
Another interesting path of exploration would be using our methodology to observe another
industry and potentially lead, later on, to enhanced product coverage and detailed sector
oriented research. Since we know purchasing departments share main common features
between different industries, it would be intriguing to see how this upholds when we look at
the financial considerations of supplier selections between several selected sectors of activity.
Additionally, another partnership type of research focusing this time on the possible broader
uses of financial models within the entire supply chains to: heighten performances, clear-out
inefficiencies and mitigate risks, would be truly insightful for this area of study.
A last possible suggestion would be, to perform a sensitivity analysis of either the Oil & Gas
industry over the past 25 years, or one specific segment. This would allow to only focus on
bankruptcy signs and its specific timeframes which could lead to comprehensive studies on
the details of disruptive events within the industry. Thus, enabling researchers to create a
unique bankruptcy prediction model with strong precision properties, growing from our
warning score and different support studies.

171
Develop an innovative paper to lead the way and further expose this somewhat forgotten research area.

86

Finally, as we can see, the opportunities for further research are bountiful. The study has
really opened new doors regarding the role financial evaluation holds within supply chain
management and the impact it has on rising risk management concerns.

Personal reflections and analysis of the work
Our experience during this research has been truly plentiful. First, from the knowledge we
have gained in our respective fields but also in the methodology we acquired developing our
study. Additionally, the different hardships we had to deal with (finding valid data, precise and
relevant bankruptcy information, going through a large amount of academic documents or
even interviewing different professionals) taught us how to handle complex situations.
We also learned a lot regarding the limits of accomplishing such studies as we have
mentioned, regarding the width of our analysis, time constraints and also the difficulties in
capturing fast changing trends and evolutions. This is why, we believe, that in order to
perform the best study possible we could have benefited from an even closer relationship with
our partner company in terms of a daily collaboration. This would allow business and research
to intertwine and make the investigations as representative and relevant possible for the
industry professionals targeted by this type of developments.
Finally, our work has enabled us to answer the different questions (academic and business
related) we set out to resolve. Thus, helping our partner company develop a warning model,
review the global industry data and perform a comprehensive analysis in order to make
relevant comments and reach important conclusions. Ultimately, working on such a practical
research paper has given us invaluable insight into the operations and various features of
Contracts & Procurement Departments within the Oil & Gas industry.

87

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de Servigny, Arnaud and Olivier Renault (2004). The Standard & Poor's Guide to Measuring
and Managing Credit Risk. McGraw-Hill.
Eljelly, A., 2004. Liquidity-profitability trade off: An empirical investigation in emerging
market. Int. J. Comm. Manage., 14(2): 48-58.
Gordy, Michael, 2000, A Comparative Anatomy of Credit Risk Models, Journal of Banking
and Finance, January, 119-149.
Greenspan, Alan (2008-03-17). "We will never have a perfect model of risk". Financial Times.
Retrieved 2009-07-18.
Kronwald, Christian (2009). Credit Rating and the Impact on Capital Structure. Norderstedt,
Germany: Druck und Bingdung. p. 3.
Lazaridis, I., 2007. Relationship between working capital working capital management and
profitability of listed companies in the athens stock exchange. J. Finan. Manage. Anal., 19(1):
26-35.
Scott, D.F., J.D. Martin, J.W. Petty and A. Keown. Basic Financial Management (1999),
8th Edition, Prentice-Hall, Inc.
Sylla, Richard, An Historical Primer on the Business of Credit Ratings, in Richard M.
Levich, Carmen Reinhart, and Giovanni Majnoni, eds., Ratings, Rating Agencies, and the
Global Financial System. Boston: Kluwer, 2002, pp. 19-40.
Tapiero, Charles (2004). Risk and Financial Management: Mathematical and Computational
Methods. John Wiley & Son.
White, Lawrence J., Markets: The Credit Rating Agencies, Journal of Economic
Perspectives, 24 (Spring 2010), pp. 211-226.

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Bibliography Supplier Selection (Non-Cited Literature)

Bross M.E. and Zhao G., Supplier selection process in emerging markets- The case study of
Volvo bus corporation in China, Master thesis, Gteburg University, School of economics
and Commercial Law, 2004
Choi, T.Y. and J.L. Hartley. "An Exploration of Supplier Selection Practices across the Supply
Chain," Journal of Operations Management, (14:4), 1996, pp. 333-343.
Cormican, K., & Cunningham, M. (2007). Supplier performance evaluation: lessons from a
large multinational organization. Journal of Manufacturing Technology Management, 18(4),
352-366.
GUNASEKARAN, A., PATEL, C., and TIRTIROGLU, E. (2001) Performance measures and
metrics in a supply chain environment. International Journal of Operations & Production
Management, 21, pp. 71-87.
Kannan, V.R., & Tan, K.C. (2003). Attitudes of US and European managers to supplier
selection and assessment and implications for business performance. Benchmarking: An
International Journal, 10(5), 472-489.
Laura Virseda Gallego, Review of existing methods, models and tool for supplier
evaluation, Master Thesis, Linkopings Universitet (Institute of Technology), June 2011
Ordoobadi, S.M. & Wang, S. (2010). A multiple perspectives approach to supplier selection,
Industrial Management & Data, 111(4), 629-648.
Sherry R. Gordon, Supplier Evaluation and Performance Excellence: a guide to meaningful
metrics and successful results, 1st edition, J. Ross Publishing, USA, 2008, pp. 1-177.
Timmerman, E. "An Approach to Supplier Performance Evaluation," Journal of Purchasing
and Materials Management, (22:4), 1986, pp. 2-8.
Turner, I. "An Independent System for the Evaluation of Contract Tenders," Journal of the
Operational Research Society, (39), 1988, pp. 551-561.
Vonderembse, M.A. and M. Tracey. "The Impact of Supplier Selection Criteria and Supplier
Involvement on Manufacturing Performance," The Journal of Supply Chain Management,
(35:3), 1999, pp. 33-39.
Watts, C.A. and C.K. Hahn. "Supplier Development Programs: An Empirical Analysis,"
International Journal of Purchasing and Materials Management, (29:1), 1993, pp. 11-17.

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Appendix (Academic Review)

Financial Evaluation

Figure 1 (Ratio Detail Review Part 1)

(Figure made by self, based on experience and literature review)

The following 2 Figures, are summaries of all the major types of financial accounting ratios
that are and can be used during a thorough Financial Analysis process. With each ratio comes
the formula and the explanation for each element to enable the reader the methodology and
logic behind each element. The purpose of these Figures is to show the variety of ratios at the
disposal of analysts. All with unique explanatory power (show slow inventory rotation,
decreasing liquidities, high leverage levels, poor asset utilization, etc.), covering many
different possible situations and scenarios.

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Figure 2 (Ratio Detail Review Part 2)

(Figure made by self, based on experience and literature review)

Link 1 (Mertons DD model)
http://www.stockopedia.com/content/improving-on-the-altman-z-score-part-3-mertons-
distance-to-default-70965/

Link 2: (CHS Model)
http://www.stockopedia.com/content/improving-on-the-altman-z-score-part-1-the-chs-
model-70693/

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Supplier Selection

Figure 3 Supplier Selection Process Outlay

This figure shows us in a resume format, what the supplier selection process as whole looks
like. The purpose is to give a general idea of what the procedure looks like to better
understand the explanations a literature review ahead. The 3 main steps and all the sub-factors
of the process outlay are detailed later on in the academic review.

Reggie Davidrajuh, (2003) "Modeling and implementation of supplier selection procedures
for e-commerce initiatives", Industrial Management & Data Systems, Vol. 103 Iss: 1, pp.28-38

Figure 4 Selection Criteria Ranking

The Supplier Selection Process in the Swedish Pulp Industry - A Contingency Perspective.
Johan Elfving, Jimmy Sundqvist - Lule University of Technology (Department of Business,
Administration, Technology and Social Sciences) June 2011

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Figure 5 Supplier Criteria for Performance Evaluation

Nikhil Chandra Shil - Customized Supplier Selection Methodology: An Application of Multiple
Regression Analysis - Supply Chain Forum an International Journal Vol. 11 - N2 2010

102

Figure 6- Supply chain risks and the related descriptions

Sabine Matook, Rainer Lasch, Rick Tamaschke, (2009) "Supplier development with
benchmarking as part of a comprehensive supplier risk management framework",
International Journal of Operations & Production Management, Vol. 29 Iss: 3, pp.241 267

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Extra Research 1 List of Supplier Selection Criteria

Customized Supplier Selection Methodology: An Application of Multiple Regression
Analysis - Nikhil Chandra Shil - Supply Chain Forum An International Journal Vol. 11 - N2
2010

List of the major criteria some authors cite and elaborate on in their academic research.

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Extra Research 2 Methodology Review

A REVIEW OF SUPPLIER SELECTION METHODS IN MANUFACTURING
INDUSTRIES - Farzad Tahriri, Mohammad Rasid Osman, Aidy Ali and Rosnah Mohd Yusuff
- Sept 24, 2007; Revised: Jun 2, 2008; Accepted: Jul 29, 2008 - Suranaree J. Sci. Technol.
Vol. 15 No. 3; July - September 2008

Some authors propose linear weighting models in which suppliers are rated on several criteria
and in which these ratings are combined into a single score such as the categorical model. The
categorical model is a simple method, but it is also the quickest, easiest, and least costly to
implement. However, it may be influenced by recent events and usually implies a high level
of subjectivity and therefore it is imprecise (Petroni, 2000).The weighted point model is also
easy to implement, flexible, and fairly efficient in the optimization of supplier selection deci-
sions. It is more costly than the categorical method, but tends to be more objective, even
though it relies on the buyers assessment of the supplier performance.

Total cost approaches attempt to quantify all costs related to the selection of a vendor in mon-
etary units. This approach includes cost ratio (Timmerman, 1986) and Total Cost of Owner-
ship (TCO) (Ellram, 1990). The cost ratio method is very flexible. It is a complex method that
requires a developed cost accounting system. The total cost model is precise, expensive to
implement due to its complexity and requires more time and implies the ability to identify the
more important elements.

Mathematical programming models often consider only the more quantitative criteria; this
approach includes the Principal Component Analysis (PCA) and the Artificial Neural Network
(ANN). According to Bello (2003), the PCA method has two advantages that are accessible
and capable of handling multiple conflicting attributes. The ANN model saves money and
time. The weakness of this model is that it demands specialized software and requires quali-
fied personnel who are expert on this subject. Over the years, researchers have begun to clas-
sify and group the individual supplier selection methods into a number of broader categories,
with each classification having both advantages and disadvantages.The Multiple Attribute
Utility Theory (MAUT) method has the advantage that it enables purchasing professionals to
formulate viable sourcing strategies and is capable of handling multiple conflicting attributes.
However, this method is only used for international supplier selection, where the environment
is more complicated and risky (Bross and Zhao, 2004). According to Chen-Tung et al. (2006),
the Fuzzy logic approach measures for supplier performance evaluation. This approach can
help Decision Making (DM) to find out the appropriate ordering from each supplier.

Another useful method is the Analytical Hierarchical Process (AHP), a decision-making
method developed for prioritizing alternatives when multiple criteria must be considered and
allows the decision maker to structure complex problems in the form of a hierarchy, or a set of
integrated levels. The AHP is relatively simple to use and understand. This method incorpo-
rates qualitative and quantitative criteria. A review of the supplier selection literature shows
that the AHP method to be one of the most commonly applied methods in practice. AHP is an
ideal method for ranking alternatives when multiple criteria and sub criteria are present in the
decision-making process. The AHP was introduced by (Saaty, 1980). There has been wide

105

discussion about the empirical effectiveness and theoretical validity of this technique. Similar
to that of the MAUT, AHP allows the decision-maker to structure complicated problems in the
form of a decision hierarchy. The hierarchy usually consists of three different levels, which
include goals, criteria, and alternatives. AHP is often considered as a supplier selection meth-
od because it allows decision makers to rank suppliers based on the relative importance of the
criteria and the suitability of the suppliers (Saaty, 1980). AHP offers a methodology to rank
alternative courses of action based on the decision makers judgments concerning the im-
portance of the criteria and the extent to which they are met by each alternative. For this rea-
son, AHP is ideally suited for the supplier selection problem.

The problem hierarchy lends itself to an analysis based on the impact of a given level on the
next higher level. The process begins by determining the relative importance of the criteria in
meeting the goals. Next, the focus shifts to measuring the extent to which the alternatives
achieve each of the criteria. Finally, the results of the two analyses are synthesized to compute
the relative importance of the alternatives in meeting the goal.

Managerial judgments are used to drive the AHP approach (Yusuff et al., 2001). These judg-
ments are expressed in terms of pair-wise comparisons of items on a given level of the hierar-
chy with respect to their impact on the next higher level. Pair-wise comparisons express the
relative importance of one item versus another in meeting a goal or a criterion. Each of the
pair-wise comparisons represents an estimate of the ratio of the weights of the two criteria
being compared. Because AHP utilizes a ratio scale for human judgments, the alternatives
weights reflect the relative importance of the criteria in achieving the goal of the hierarchy
(Maggie and Tummala, 2001).
The use of AHP is increasing with time; since a lot of journals are bringing out special issues,
on this topic. Omkarprasad, and Kumar, 2006 have written an excellent review and shown the
percentage use of the AHP method during the specified time periods. The use of the AHP ap-
proach offers a number of benefits. One important advantage is its simplicity (Liu and Hai,
2005). AHP can also accommodate uncertainties and subjective information, and allows the
application of experience, insight, and intuition in a logical manner. It is observed that AHP is
being predominantly used in the area of selection and evaluation (Maggie and Tummala,
2001).

Finally, if a firm follows a single sourcing strategy, the task is to select the best supplier
among all alternatives that satisfies the firms requirements. In such a case, a single decision
making method capable of ranking alternative suppliers, such as MAUT and AHP, can be
used. Multiple methods may be needed for selecting multiple suppliers if a multiple sourcing
strategy is followed. This is because there are two types of decisions when a multiple sourcing
strategy is pursued by the buyer: (i) how many and which suppliers to select and (ii) how
much purchase should be made from each supplier selected (Karpak et al., 1999)

106

Extra Research 3 Supplier Selection and Assessment

Kannan, Vijay R., Tan, Keah Choon; 2002 Supplier selection and assessment: their impact on
business performance. Name: Journal of Supply Chain Management Publisher: National
Association of Purchasing Management, Inc.

Using the categorization scheme in Eliram (1990), supplier selection research can be
categorized as either descriptive, describing actual practice, or prescriptive, modeling how
suppliers should be selected given a set of selection criteria. Descriptive studies have
addressed a wide array of issues. Early studies focused on identifying the criteria used by
buyers to select suppliers (e.g., Dickson 1966; Lehmann and O'Shaughnessy 1982). These
have been extended to identify supplier selection under specific buying conditions; for
example, strategic buyer-supplier partnerships (Hiram 1990), single versus multiple sourcing
(Swift 1995), routine versus non-routine purchases (e.g., White 1978; Dempsey 1978;
Johnson 1981; Lehmann and O'Shaughnessy 1982), and direct versus indirect materials
(American Machinery Manufacturers Association 1985). Several studies have also examined
the relative importance of different selection criteria under different buying conditions (e.g.,
Lehmann and O'Shaughnessy 1974, 1982; Evans 1 982; Wilson 1994). While cost, quality,
and delivery performance have been consistently identified as being important determinants
of supplier selection, it is also apparent that specific criteria and their relative importance are
highly dependent on the type of purchase being made. A study by Verma and Pullman (1998)
investigated whether selection criteria are consistent with their perceived importance in the
eyes of purchasers. While quality was determined to be the most important selection criterion,
selection decisions were more likely to be made on the basis of cost and delivery
performance.

A number of studies have addressed supplier selection in the light of contemporary business
pressures. Choi and Hartley (1996) examined supplier selection for companies at different
points in the supply chain. Several studies have addressed issues pertinent to purchases made
in global markets (e.g., Min et al. 1994; Thorelli and Glowacka 1995; Deng and Wortzel
1995; Katsikeas and Leonidou 1996; Piercy et al. 1997). Two recent studies have examined
the impact of environmental pressures on buying behavior (Dobilas and MacPherson 1997;
Min and Galle 1997). There has also been interest in recent years in supplier selection in
specific industry settings such as the Japanese electronic component industry (Hirakubo and
Kublin 1998), systems/software (Gustin et al. 1997), and healthcare (Lambert et al. 1997).

Prescriptive research in supplier selection has used a variety of methodologies including
mathematical programming (e.g., Turner 1988; Pan 1989), weighted average methods
(Timmerman 1986; Thompson 1990), payoff matrices (Soukup 1987), and the analytic
hierarchy process (Narasimhan 1983; Nydick and Hill 1992; Barbarosoglu and Yargac 1997).
(1) Additionally, a number of studies have examined the criteria used by buying firms to
assess supplier performance (e.g., Monczka and Trecha 1988; Giunipero and Brewer 1993;
Watts and Hahn 1993; Walton et al. 1998; Carr and Pearson 1999). The evidence suggests that
while cost is the primary criterion, quality, delivery, and service are also commonly used.

107

Despite the volume of research, particularly in the area of supplier selection, little attempt has
been made to identify the impact of supplier selection and assessment on the buying
company's business performance. Vonderembse and Tracey (1999) surveyed purchasing
managers with the intent of determining the extent to which manufacturing companies used
various supplier selection and supplier involvement tactics, and how these impacted
manufacturing performance. While there was extensive use of the supplier selection criteria
presented, the same was not true for supplier involvement.
Finally, some academic reviews and research have pointed out that attention has so far been
paid to the choice phase in the supplier selection process. The phases prior to it (problem def-
inition, criteria formulation and qualification) have received far less attention from research-
ers in operations research or purchasing and supply. However, the quality of the choice phase
is largely dependent on the quality of the steps prior to that phase. If purchasers strive for
sound decision making they should also pay attention to these early steps.

Extra Research 4 Vendor Selection, Processes & Practices

A Review and Critique of Supplier Selection Process and Practices - by Mahmut Sonmez -
Business School Occasional Papers Series - Paper 2006: 1

Buyer-seller relationships

Twenty-nine out of 147 articles reviewed examined the influence of buyer-seller relationship
on the supplier selection process. There is now wider consensus among scholars that there has
to be a strong collaboration between the buyers and the sellers as opposed to the idea that the
buyers and sellers are adversaries. One important observation about the papers related to
customer-supplier relationships is that majority of these papers appeared from the late 1990s
up until the present time. This suggests and shows that more and more emphasis is placed on
non-technical, non-qualitative aspects of the supplier selection process.

I nternational Supplier Selection

Another area that has attracted research interest in the last five years is that of international
supplier selection. Eighteen out of 147 articles reviewed focused on international supplier
selection. Many companies have now realized the opportunities in terms of lower production
and labor costs that other countries can offer. Then, it becomes necessary to understand and
analyze these countries political, legal, economic, socio-cultural and technological features as
well as how to go about doing business in these countries. Selecting suppliers in foreign coun-
tries may then become complicated due to the uncertainties caused by lack of information
and/or risks (such as safety and security related) associated with these countries business en-
vironment. The selection of international suppliers may involve more criteria and require
more time to gather information to evaluate potential suppliers. It was observed from the re-
view that the papers reporting the various aspects of supplier selection process in a particular

108

country is limited with mainly developed (technologically advanced) countries. USA is most
widely studied country. Other countries include Canada, Germany, The Netherlands, Switzer-
land, Sweden, China, Japan and Korea. Although an effort was made to build a model for
supplier selection in developing countries in, there is not much evidence how supplier selec-
tion process is carried out in developing countries.

E-procurement: Online Supplier Selection

The world has seen rapid developments in information technology and electronic data inter-
change in particular over the last two decades. The extensive use of the Internet has enabled
buyers to locate large number of suppliers and has provided opportunities for suppliers to let
buyers know of their existence. The Internet has become an e-marketplace where buyers and
sellers interact electronically. However, surprisingly, there were only nine papers focusing on
e-procurement mainly from buyer-seller relationship point of view.

This paper aimed to explore the various issues affecting the supplier selection process. The
wide ranging literature review suggests that much of the focus on supplier selection process
has been given to the decision criteria and the decision making methods used for evaluating
and selecting suppliers. There is now some evidence that more efforts are being made in ex-
amining the effects of buyer-seller relationship, international supplier selection and e-
commerce (evaluating and selecting suppliers online) on the supplier selection process. The
shift towards the qualitative and non-numerical aspects of supplier selection process clearly
supports the idea that buyers benefits from considering these qualitative and non-numerical
factors. However, the problem of how to quantify and measure these qualitative factors still
remains to be tackled. A model incorporating both qualitative and quantitative criteria in a
rational and systematic way is needed. Further research efforts should be made towards build-
ing such a detailed model by considering all qualitative and quantitative criteria.

I ndustry Specifics
The relative importance of supplier selection tends to vary substantially depending on the
sector or even industry. When we look at traditional industrial/engineering companies, most of
them tend to use outsourcing, externalization of processes and heavy reliance on suppliers or
other partners. This is mostly due to the fact that many different technical aspects are involved
within such companies and generally one firm or group cannot handle all of them efficiently.
Hence automobile, energy, telecoms, real estate, oil & gas and manufacturing are typical
examples of industries where the supplier selection is at the heart of the business. This
reliability and importance between partners as intensified supplier selection processes in these
sectors as mistakes have proven very costly in the past as we have shown. However, with less
supplier / vendor dependent sectors such as service companies, media and technology and
financial institutions, the selection process for suppliers is different and not so systematic. In
these areas the focus is more on specific needs for specific situations, since in general their
procurement tend to be smaller and less active. Finally, these industries will also show much
lower exposure towards the suppliers they work with, however the downside may be a trend
towards leniency, regarding the qualification criteria and assessment processes in place.

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Extra Research 5 Study on Supplier Risks

Strategies for managing customer and supplier risks - The Economist Intelligence Unit
Limited, 2013
https://docs.google.com/viewer?url=http://www.economistinsights.com/sites/default/files/EI U+D%26B+paper
+FI NAL+Nov+21+with+new+logo.pdf&chrome=true

(Please refer to this business article as it provides many insights into procurement management)

110

Shows that according to this survey; financial risk is considered as the major risk as it is the
most actively managed risk.

High Performance in Procurement Risk Management- Research and insights developed in
collaboration with Massachusetts Institute of Technology Accenture, 2010
http://www.accenture.com/SiteCollectionDocuments/PDF/Accenture_High_Performance_in_Procurement_Ri
sk_Management.pdf

(Please refer to this business article as it provides many insights into procurement management)

111

112

Appendix (Practical Section)

Summary of appendices

Exhibit A: Financial analysis methodology
- Showcases the complete process on how to perform a financial analysis, using Totals
methodology. From N1 to N19, each step of the model, its impacts and how it
operates are detailed.

Exhibit B: Supplier selection process and registration document, from N1 to N5.

Exhibit C: Corresponds to materiel relevant in the methodology section N1 to N4.
Where N2, 3 and 4 are all self-made.

Exhibit D: Showcases elements from the practical section. More specifically linked with
the analysis and discussion part, putting forward the different elements we have developed
(Tables, Models, Tools, Tests, and Scenario Analyses). Everything is self-made.

113

Exhibit A Financial Evaluation

N1) Financial Evaluation Process - Step 1

114


115


116


117


118


119


120


121

N 9) Financial Evaluation Process - Step 9

122


123

N 11) Financial Evaluation Process - Step 11

124

N12) Brokers note sample Part 1

125

N 13) Brokers Note Part 2

N14) Brokers Note Part 3

126

127

N15) Total Financial Analysis Model Part 1


128



129


130

Exhibit B Supplier Selection Process

Here is the full supplier qualification process, detailed and explain step by step. We can
see the essential role financial evaluation plays within this process (step 3). It is one of the
deciding factors in the qualification of suppliers and can lead to further investigations
and different tests being performed if initial financial requirements are not met.

N1) Full Supplier Qualification Process

131

N2) Supplier registration form part 1

132



133


134

Exhibit C - Methodology

N1) Links which helped us for the Factor Selection in the reference table

http://www.stat.purdue.edu/~junxie/selection_final.pdf

http://www.energydigital.com/oil_gas/top-20-risk-factors-facing-the-oil-gas-
industry

http://www.dbrs.com/research/258883/rating-companies-in-the-oil-and-gas-
industry.pdf

135

N2) Professional Interview

(Katier Bamba Senior Financial Analyst, Contract & Procurement)

Here are the 6 main questions that were asked during our interview, however as you can
imagine during our many discussions with different professionals at Total we have gathered
much information that has helped us complement all our different parts of this project. Each
meeting and discussions could not for different reasons have been recorded but they have
given us incredible business insight into this incredibly complex and long process. Helping us
understand and better deal with our topic both academically and practically.

1) What weight does financial analysis carry in the selection process? Why?

Financial Analysis carries a more important role than most people in contract & procurement
could imagine. Knowing if a supplier will be able to maintain its activity on a financial basis
is something key in developing strong partnerships and healthy supplier relationships. The
importance is even higher when the contract durations tend to be longer. Over a long period
many factors can come into play and influence negatively a supplier and thus hinder their
capacity to honor the contract. With regards to shorter term contracts or (one-offs) contracts,
the risk in minimal as there is much less probability a partner will either default or fail to
honor the contract over such short period of time. Finally, it is important to mention that at
Total the financial evaluation of supplier is considered as a stop & go process. If 2 suppliers
show strong financial health, then as you can imagine it will not be the main decision factor in
the selection. However if suppliers tend to show some minor or major signs of weaknesses but
tend to have a good technical record, then the financial evaluation will play a key role in the
selection and qualification of these suppliers. Ultimately, as you can see, this process is not as
clear cut as you could find it well written in academic literature, nonetheless, financial
analysis is a great help to our decision making process and a key part of our overall process.

2) How can Financial Analysis help mitigate risks both financial and operational?

Financial Analysis can especially help in the department of warning versus possible
disruptions and bankruptcy events. The probability of such events is the real risk, and
financial evaluation of suppliers helps reduce such probability and the possible operational
repercussions these can have on the business.
Also, we have noticed tendencies for suppliers who had poor financial conditions to provide
poor services or poor quality products. It was not always the case of course, but on average it
was a tendency we have observed. Moreover, the ability to use financial analysis as a warning
tool has been very important to us in negotiations or renegotiations of contracts situations.
The observed correlation between the two also showed us the importance of our different
financial evaluation processes in place. Despite taking some time to be put into place and
convince everyone in the different departments that it was a necessity and not just a (luxury)
we couldnt afford to forgo.

136

Standardizing the financial review has been one of the key elements in the past years with the
increasing worldwide economic uncertainties. Thus, being able to review financially supplier
has been able to do many things (warn of potential faulty suppliers, focus on grey areas,
review contracts accordingly, mitigate risks, prevent operational mishaps, etc.). One last
example I would like to use is to show how financial analysis can simply help mitigate
operational risks. If a supplier over the past 10 years has been having steady cost levels,
steady sales and revenues but all of the sudden this year, costs decrease and revenues increase.
This can be a warning to a supplier decreasing costs, lowering product quality, to increase per
product margins, thus impacting the end client who receives lower quality products. Financial
analysis does not have all the answers or solves all issues, but it helps pick up things that need
further analysis, helps in the decision making process between 2 closely held suppliers and
mitigate risks in disruptive situations.

Ultimately, having thorough selection and qualification standards on all financial, technical
and operational levels have been I believe at the heart of the maintained success here at
Total.

3) Do you think the tools and technics available today are efficient enough? What about
Total? How you think this has changed in the last years?

In many cases where fast paced disruptions where the issue, I must admit, that our core
business not being investment of financial analysts at heart as lead us to sometimes be slow to
react. The tools at our disposal have been and are good ones for us to do our job correctly, but
of course its always possible to have more, the question is, is it really worth it for the purpose
of our activity where financial evaluation is a part of a bigger overall selection process. I think
the best tool at our disposal and that we are really trying to implement as part of a bigger
global objective is the education and awareness of the people in the business to these possible
disruptions. Because our best asset is our people and no amount of standardized methods,
tools or evaluation technics will replace experience and knowhow. However, this said, I
wouldnt be able to do my job efficiently without those aforementioned tools and they are
essential but should in no way be over depended on. Finally, where we could also improve is
in the frequency of our analyses and the follow up of certain suppliers, as we have so many in
play, it is sometime hard to keep track of non-active partnerships, short contracts and other
specific situations. Some cases are hard to handle for instance if the supplier of one of our
suppliers goes bankrupt, it is not something we might be aware of, then in these cases, good
relationships or alternative information methods are key in the risk mitigation process.
Ultimately over the years I think this is an area which has tremendously evolved. 10 or 15
years ago financial evaluation honestly was a tiny fish in the pond or in some firms inexistent.
The main criteria, was can this supplier do the job well and in time. However with the
financial crisis, the European debt crisis and many other worldwide events in Japan and other
countries, companies realize more and more the different complex risks involved within our
business. These risks are more than operational risks and credit risk and the possibility of
certain partners and suppliers to go bankrupt of come into different trouble can be very
damaging. Maybe its a lesson we have learned to late, with many big firms apparently too big
to fail but apparently in the end not. Its this incredible change of landscape that had really
pushed the industrials to question their methods and implement stronger risk management
tools and develop stronger financial evaluation processes to minimize these risks.

137

4) What are the most important factors (5) to take into consideration for the review of
oil & gas companies?

The most important factors to take into consideration for me are:

- DEBT / EQUITY: it is very important ratio in the sense that having positive equity
levels is of crucial importance when judging of the financial health of a company. It
indicates what proportion of equity and debt the company is using to finance its assets.
It is a very common and useful gearing ratio shedding light on both equity data and the
proportion of debt.

- DEBT / EBITDA: This ratio is very significant, especially in Oil & Gas and more
even in the type of work we do (supplier selection, quite similar to rating methodology
and credit risk analysis). It is a common metric used by credit rating agencies to assess
the probability of defaulting on issued debt. This ratio gives the investor the
approximate amount of time that would be needed to pay off all debt, ignoring the
factors of interest, taxes, depreciation and amortization. To interpret, a high
Debt/EBITDA ratio suggests that a firm may not be able to service their debt in an
appropriate manner and can result in a lowered credit ratings and future disruptions.
On the contrary, a low ratio can suggest that the firm may want take on more debt if
needed and it often warrants a relatively high credit rating.

- EBITDA Margin: EBITDA is a good proxy for the cash flow of the companies and this
ratio is a good measurement of a company's operating profitability.

- Backlog levels: are important because they attest of the upcoming activity of the
supplier but also eventually of the future untapped contracts in term of cashed in
projects which is a good indicator of future revenues and cash flows.

- Net cash positions: They are important in an industry where the variations and changes
tend to be very frequent. Thus having a comfortable cash position can be a comforting
factor when selecting a supplier but also an indicator of strong liquidity and cash
management.

- Sales growth: Is truly a key simple indicator of the activity performance and where it
is heading towards. Looking backwards too, comparing with different events helps to
learn how companies react to different situations (positive and negative), and showing
the potential weaknesses and strength of said suppliers.

- Current ratio: It is a great and common liquidity ratio that measures a company's
ability to pay short-term obligations. For instance, the current ratio can give a sense of
the efficiency of a company's operating cycle or its ability to turn its product into cash.
In the Oil & Gas sector this is a very sensitive and observed ratio because companies
that have trouble getting paid on their receivables or have long inventory turnover can
run into liquidity problems because they are unable to alleviate their obligations. Thus,
exposing the other companies they work alongside with.

138

- Interest coverage: This is a very good ratio to analyze because it is used to determine
how easily a company can pay interest on outstanding debt. However be careful as the
Oil & Gas sector can have misleading EBIT values compared to interest expenses.
Despite not the best factor for this study, it is interesting to have in mind, because a
company that barely manages to cover its interest costs may easily fall into bankruptcy
if its earnings suffer for even a couple of months.

- Respect of covenants: When we talk about disruptions and breach of contracts, there
is little better indicator then this one. However, it is not unfortunately easily
retrievable information, not easily interpretable and also quantifiable unfortunately.
But it is an element that should be taken if possible under consideration because it
describes the suppliers attitude, track record and operations on different levels.

- Credit lines: It is an indicator that many institutions fail to take into consideration but
for me is of key importance. For instance if a technically astute supplier has indebted
itself extensively to develop its R&D department and furnish better quality products.
Financially this may appear as an overburden of debt compared to its current
activities. However future revenues from this amelioration of product might not be
perceived straight away. Thus, a supplier with an ease of access to credit, or has at its
disposal if needed different credit lines or other debt facilities then, its should be
taken into consideration when judging the supplier in terms of solvency.

- The Altman score as your dependent variable for the regression is also an important
element and dataset to retrieve.

Of course not all of these factors can be taken into consideration into normal financial
analysis and evaluations and even less in standardized methods. However I believe that
having like you selected 5 elements and variables to perform a model is a good proxy to
evaluate suppliers. Simple yet representative enough of key elements in the sector. It should
give us good results to create a nice decision helping tool and also warning model, very easy
to use clearly helping us in our supplier financial coverage, as I have mentioned before that
time is something we often lack of.

Finally, I believe some factors are important to take into consideration specific to each
sectors. For instance its advised not to take net income as a reference because of large non
cash metrics are included and clouds the overall picture, so use EBIT or EBITDA as a more
useful variable, hence my previous choices. I also advise to be cautious with total asset based
ratios as the oil and gas industry is usually a very fixed asset intensive and thus could cloud
the overall evaluation.

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5) What is the difference between the academic vs. business reality in financial
evaluation of suppliers/companies in your opinion? What does theory fail to grasp about
business reality?

First and foremost the big difference lies in the purpose of financial evaluation. In theory, the
most looked at aspect is profitability which could more easily be related to a vision of
assessment closer to those of brokerage firms or investment analysts (are the stocks worth
buying, or are the companys dividends high enough, what about the earnings, etc.).
Meanwhile the business reality of things and especially in the industry, financial evaluation of
companies is more related to the risk. Such analysis is performed as risk management
processes and help to better understand, mitigate and contain different financial or operational
risks. Thus, in practice financial evaluation of suppliers for example can be more closely
related to a rating type of methodology (will the company be able to pay its debt and thus
subsist long enough to honor the terms of the contract, is the EBIT high enough to cover the
interest payments, what about the cash flows, etc.). So as you see in more practical settings
the financial analysis and evaluation can even be called a credit analysis where focus is
especially strong on liquidity and solvency ratios.

Furthermore, a very important point to mention is that financial analysis takes into
consideration historical information and book data. Experience has shown us that for our
procurement purposes these were generally sufficient. However there is always the odd case
and that is when all the different processes, methods and tools develop come in handy.
However it is undeniable that we need more up to date information, such as the evolution of
payments, capacity to obtain new business and close new deals and retain old ones, so on and
so forth.

Finally, business constraints are not the same ones represented in academic basis. They are
simple to changing, to recurrent, to evolving for literature to take them into account
efficiently. Where, practice based methods have an advantage is that they do take into account
this potential change and are thus more flexible in their process and allow for different inputs
to tailor the different methods used. Meanwhile theoretical fundamentals or procedures tend
to revolved around a not so flexible axis that doesnt allow them to take into consideration so
many of the specifics involved in such complex business oriented proceedings that are
procurement and especially in the oil & gas industry.

6) How have you dealt with supplier disruptions in the past before? Can thorough
qualification standards help reduce these supplier risks?

First and foremost we have been fortunate, having implemented different risk management
processes to have not been heavily impacted by supplier disruptions. However more and more
these disruptions take different forms (risk of image, safety issues, new regulations, political
innuendos, so on and so forth).
Moreover, many factors need to be better understood regarding the different suppliers we use.
For instance studies on their credit history, their respect of different covenants, contract
specifics, internal management information and other key elements which impact in any way
the normal activity of a supplier.

140

Regarding the past disruptions, we have always taken early action or even anticipation
methods. Depending on the gravity of the situation different measures have been deployed (is
the supplier on the way to being bankrupt and things can change or have they already filed for
bankruptcy or closed shop?). Different environments require different reactions and keeping a
strong brand image in these instances in of the utmost importance.
Finally over the course of my experience here at Total I have noticed that treating risks in a
one-dimensional fashion was not something efficient for the firms wellbeing. Financial risks,
operational risks, legal risks, and others are all interlinked together and ignoring this fact can
be very costly to a business. I think this is why its very important like I have mentioned
before, when performing an evaluation be it financial or not, to always incorporate elements
from business & operations as well as finance, to get the best overall view of the situation. If
for instance, you know by keeping close relationship with a supplier, that the top management
is going to change soon, then that factor can be taken into consideration during the financial
evaluation in a positive way if we feel so and not if we feel otherwise. Having this breadth of
information, quantitative and qualitative is for me the most important factor a sound and
efficient evaluation of suppliers to best prevent disruptions.

141

N3) Output Range / Benchmark Development

To create our Range / Benchmark we have developed a table, look at the below
screenshot.

We have modelled the following Table throughout 4 different steps:

- Vertical Axis: It consists of our 5 selected evaluation factors and their respective
weights obtained from the previous developed equation via the multiple regression.
- Horizontal Axis: Comprises of an established range representing our grading universe
(0 minimum grade and 10 maximum grade).
- The table: The information itself within the table corresponds to the observed data
gathered from our previously created Master Table. Additionally to make sure our
range is of the highest precision we will consult on a regular basis with Total and its
financial analyst, benefitting from its industry wide vision, knowledge and most
importantly their existing benchmark studies. We will observe all our various gathered
information and create an individual factor benchmark for each of our elements
(variables). Once this array is established we will have a composite of 5
comprehensive different ranges.
- End score: Finally, the last two lines of our table include the equation result: First line
is the intercept which needs to be added to our previous developed ranges. Second we
use the pre-established equation formula and provide an end score for each value of
the array from (0 to 10) for each factor. Thus, we will have obtained a unique
composite benchmark representative of our scoring model, taking into account all our
analyzed elements but also all the industry data we have found over the 10 year
period.

142

143

N4) Conversion table for support test C

144

Exhibit D Practical Section (Tables, Models, Tests and Scenario Analysis)

N1) Screenshot sample - Master Table + Master Table Inputs

145

146

N2) Screenshot sample - Outputs & Multiple Regression Specifics

147

148

N3) Screenshot sample - Support tests A (Graphs and Charts)

149

150

N4) Screenshot sample - Support test B Type Ranking Recap Table

151

N5) Screenshot sample - Support test C Grading Table comparison

152

N6) Screenshot sample - Scenario Analysis + Supplier Alert News

153

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