ASSESSING AND

MONITORING THE
ECONOMIC AND
FINANCIAL STANDING
OF SUPPLIERS
Guidance Note

July 2019
 ASSESSING AND MONITORING THE ECONOMIC AND FINANCIAL STANDING OF SUPPLIERS

Contents
1. Introduction ..................................................................................................................... 4
1.1. Issue ........................................................................................................................... 4
1.2. Dissemination.............................................................................................................. 4
1.3. Timing and Scope ....................................................................................................... 4
1.4. Contact ........................................................................................................................ 4

2. Assessing the Economic and Financial Standing of Bidders..................................... 5

2.1. Background ................................................................................................................. 5
2.2. Principles .................................................................................................................... 5
2.3. Financial testing .......................................................................................................... 6
2.4. Demonstrating economic and financial standing ......................................................... 8
2.5. Financial information required from bidders .............................................................. 10
2.6. Application to groups and guarantors ........................................................................ 11
2.7. Application to joint ventures and consortia ................................................................ 12
2.8. Application to sub-contractors ................................................................................... 12
2.9. Application to framework agreements and call-off agreements ................................. 13
2.10. Application to construction projects and other special cases .................................... 13
2.11. Use of credit ratings and credit scores...................................................................... 14
2.12. Support ..................................................................................................................... 14

3. Mitigating Financial Risk .............................................................................................. 15

3.1. Introduction ............................................................................................................... 15
3.2. Insurance .................................................................................................................. 15
3.3. Guarantees ............................................................................................................... 16
3.4. Bonds ........................................................................................................................ 16
3.5. Financial Distress Events .......................................................................................... 17
3.6. Other methods to mitigate financial risk .................................................................... 18

4. Monitoring the Economic and Financial Standing of Suppliers following Contract

Award ............................................................................................................................. 20
4.1. Background ............................................................................................................... 20
4.2. Principles .................................................................................................................. 20

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4.3. Identifying and monitoring key suppliers ................................................................... 21

4.4. Coverage ................................................................................................................... 22
4.5. The importance of access to liquidity ........................................................................ 23
4.6. Access to forward looking information ....................................................................... 23
4.7. Annual confirmation of compliance............................................................................ 24
4.8. Follow up ................................................................................................................... 25
4.9. Information sources and support ............................................................................... 25

APPENDIX I – Standard Financial Ratios ........................................................................... 26

Metric 1 – Turnover Ratio....................................................................................................... 28
Definition ......................................................................................................................... 28
Interpretation ................................................................................................................... 28
Benchmark ...................................................................................................................... 28
Potential mitigations ........................................................................................................ 28
Metric 2 –Operating Margin.................................................................................................... 29
Definition ......................................................................................................................... 29
Interpretation ................................................................................................................... 29
Benchmark ...................................................................................................................... 29
Potential mitigations ........................................................................................................ 29
Metric 3(A) – Free Cash Flow to Net Debt Ratio .................................................................... 30
Definition ......................................................................................................................... 30
Interpretation ................................................................................................................... 31
Benchmark ...................................................................................................................... 31
Potential mitigations ........................................................................................................ 31
Metric 3(B) – Net Debt to EBITDA Ratio ................................................................................ 32
Definition ......................................................................................................................... 32
Interpretation ................................................................................................................... 33
Benchmark ...................................................................................................................... 33
Potential mitigations ........................................................................................................ 33
Metric 4 – Net Debt + Net Pension Deficit to EBITDA Ratio .................................................. 34
Definition ......................................................................................................................... 34
Interpretation ................................................................................................................... 35
Benchmark ...................................................................................................................... 35
Potential mitigations ........................................................................................................ 35
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Metric 5 – Net Interest Paid Cover ......................................................................................... 36

Definition......................................................................................................................... 36
Interpretation .................................................................................................................. 36
Benchmark ..................................................................................................................... 36
Potential mitigations........................................................................................................ 36
Metric 6 – Acid Ratio .............................................................................................................. 38
Definition......................................................................................................................... 38
Interpretation .................................................................................................................. 38
Benchmark ..................................................................................................................... 38
Potential mitigations........................................................................................................ 38
Metric 7 – Net Asset Value .................................................................................................... 39
Definition......................................................................................................................... 39
Interpretation .................................................................................................................. 39
Benchmark ..................................................................................................................... 39
Potential mitigations........................................................................................................ 39
Metric 8 – Group Exposure Ratio ........................................................................................... 40
Definition......................................................................................................................... 40
Interpretation .................................................................................................................. 40
Benchmark ..................................................................................................................... 41
Potential mitigations........................................................................................................ 41

APPENDIX II – Interpreting standard financial metrics .................................................... 42

How to use the table ....................................................................................................... 42

APPENDIX III – Financial Assessment Flowcharts ........................................................... 44

Financial Testing Decision Tree Part 1 – Financial Assessment of Bidders .................... 44
Financial Testing Decision Tree Part 2 – In Contract Financial Monitoring ..................... 45

APPENDIX IV – Comparison of credit ratings issued by different rating agencies ....... 46

APPENDIX V – Potential indicators of future financial distress ...................................... 47

APPENDIX VI – Tools and Information sources ................................................................ 48

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1. Introduction

1.1. Issue
1.1.1 Assessing and monitoring the economic and financial standing (EFS) of suppliers is
about understanding the financial capacity of suppliers to perform a contract in order
to safeguard the delivery of public services.

1.1.2 This Guidance Note provides advice on how to:

 assess the EFS of bidders during a procurement;
 mitigate financial risks arising from the EFS of a bidder or changes to such
standing; and
 monitor the ongoing EFS of suppliers during the life of a contract.

1.1.3 The EFS of suppliers also forms part of maintaining a healthy market. This is
explored separately in the Outsourcing Playbook as part of wider market and
commercial strategy.

1.2. Dissemination
1.2.1 The contents of this Guidance Note are relevant to all Central Government
Departments, their Executive Agencies and Non Departmental Public Bodies. Such
bodies are asked to test this guidance over the next six months and feedback any
comments or recommendations for improvement.

1.3. Timing and Scope

1.3.1 In due course this Guidance Note is expected to apply to all new procurements with
an expected contract value exceeding the relevant public contracts regulation
threshold. In applying the guidance however, bodies are likely to be asked to
consider whether it is appropriate to their particular procurement and to adopt a
‘Comply or Explain’ approach.

1.4. Contact
1.4.1 Feedback on and enquiries about this Guidance Note should be directed to
[email protected].
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2. Assessing the Economic and Financial

Standing of Bidders

2.1. Background
2.1.1 There is a risk that a financially challenged supplier could adopt sub-optimal
behaviours, fail to deliver aspects of a contract to a satisfactory standard, or fail to
deliver a contract at all if it experiences financial distress or becomes insolvent. This
could also occur as a result of financial challenge within a bidder’s wider group or
supply chain. A Contracting Authority may then incur additional time and cost in
managing and re-procuring the contract or bringing it in-house, and any change of
supplier may come at an increased price, particularly if short-term or interim
arrangements are required. Poor delivery or failure may also have consequential
effects, for example delays to the provision of important public works and/or risks to
the quality and continuity of critical public services.

2.1.2 The purpose of assessing the EFS of bidders as part of a procurement is to assess
their financial capacity to perform the contract.

2.2. Principles
2.2.1 All assessments of bidders’ EFS should be proportionate, flexible, contract specific
and not overly risk averse while ensuring protection of taxpayer value and safety and
compliance with relevant procurement law.

2.2.2 All bidders, whatever their size and constitution, should be treated fairly and with
appropriate diligence during the assessment of their EFS. No SMEs (Small and
Medium sized Enterprises), public service mutuals or third sector organisations
should be inadvertently disadvantaged.

2.2.3 EFS should only be considered as part of the overall selection criteria. It may not on
its own reflect a bidder’s ability to deliver.

2.2.4 Assessment of EFS must be transparent, objective and non-discriminatory. It should

be based on a set of metrics and ratios appraised against pre-determined thresholds
to provide a set of risk classifications for each bidder. Bidders should be able to see
their risk classifications as they complete the financial assessment and, where
relevant, given the opportunity to explain why different risk classifications may be
more appropriate.
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2.2.5 In many cases the assessment can be based on a standardised set of metrics and
ratios. For certain contracts, however, additional or alternative metrics and ratios may
be appropriate, in particular for procurements of more critical, complex works and
services or for longer periods. Minimum financial thresholds should be appropriate
and proportionate to the contract being procured.

2.2.6 The assessment of a bidder’s EFS should be conducted by staff with a financial
background, calling on specialist in-house or external expertise as necessary.

2.2.7 Suppliers’ financial information may be available through the Supplier Registration
Service (where it is being used to complete the Selection Questionnaire), which may
reduce the burden on bidders and Contracting Authorities.

2.3. Financial testing

Contract categorisation
2.3.1 In order to determine what constitutes a proportionate assessment of EFS
Contracting Authorities should, prior to commencing a procurement, determine the
categorisation of the potential contract based upon its criticality. This should then
drive the level of EFS required from bidders and any associated requirement for
financial assessment subject matter expertise.

2.3.2 Cabinet Office has developed a Contract Tiering Tool to measure criticality. The Tool
takes into account various criteria, including the potential impact of service failure,
the speed and ease of switching suppliers and the contract value. Contracting
Authorities should use this to categorise potential contracts between ‘Gold’ (most
critical), ‘Silver’ and ‘Bronze’ (least critical) contracts. Contracting Authorities may
also categorise other potential contracts as critical or ‘Gold’ contracts.

2.3.3 Once the potential contract has been categorised, it is then possible to determine the
appropriate financial thresholds and level of financial analysis necessary. This
Guidance Note provides advice on determining financial thresholds and adopts a
‘tiering’ approach to the financial analysis, depending on the categorisation of the
potential contract.

2.3.4 Care should be taken when setting financial thresholds so as not to disadvantage
SMEs (Small and Medium sized Enterprises) and the VCSE (Voluntary, Community
and the Social Enterprise) sector. Thresholds should be proportionate to the
requirement.

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Bronze contracts
2.3.5 Bronze contracts are typically smaller, simpler contracts for non-critical works and
services. In these cases it may be appropriate to carry out a more basic financial
assessment.

2.3.6 As a starting point, Contracting Authorities may wish to use ‘off-the-shelf’ financial
analyses and risk assessments from a credit scoring agency. Contracting Authorities
should first set the credit score thresholds above which bidders are deemed to have
sufficient EFS. As a minimum, this should be 25 for a Company Watch H score and
10 for a Dun & Bradstreet score. Where a bidder falls below the thresholds set, a
more detailed assessment, including ratio analysis, should be undertaken; credit
agency scores should not be used to exclude a bidder.

Silver contracts
2.3.7 Silver contracts are typically contracts for important but not critical works and
services. In these cases a more detailed financial assessment is appropriate and
minimum thresholds should be set accordingly.

2.3.8 This assessment should use the standard financial metrics and ratios set out in
‘APPENDIX I – Standard Financial Ratios’ and the minimum thresholds in
‘APPENDIX II – Interpreting standard financial metrics’.

Gold contracts
2.3.9 Gold contracts are typically larger, longer contracts for complex or critical works and
services. In these cases a very detailed financial assessment is appropriate;
minimum thresholds should be set at the same level as for Silver contracts or higher.

2.3.10 The assessment should normally include as a minimum the standard financial
metrics and ratios set out in ‘APPENDIX I – Standard Financial Ratios’ and minimum
thresholds in ‘APPENDIX II – Interpreting standard financial metrics’. Contracting
Authorities should also consider whether to carry out additional analysis, for example
the use of additional financial metrics, ratios and/or trend analysis. Contracting
Authorities may also consider more demanding thresholds to be appropriate, taking
into account the greater and/or more complex requirements of the contract.

Decision tree
2.3.11 A decision tree showing the route to determining the recommended approach to
assessment of EFS is set out in ‘APPENDIX III – Financial Assessment Flowcharts’.

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2.4. Demonstrating economic and financial standing

2.4.1 Proof of a bidder’s EFS may be provided by one or more of the following1:
 appropriate statements from banks or, where appropriate, evidence of relevant
professional risk indemnity insurance;
 financial statements or extracts from the financial statements2, where appropriate
(i.e. where publication of financial statements is required by law); and
 a statement of the bidder’s overall turnover and, where appropriate, of turnover in
the area covered by the contract for a maximum of the last 3 financial years
available.

2.4.2 Where these proofs are not appropriate in a particular case, the Contracting Authority
may require the bidder to provide other information to prove its EFS.

2.4.3 Use of the information set out above to assess the EFS of the bidder is subject to
various shortcomings. For example, information on a bidder’s profitability, cash flow,
liquidity and solvency (typically the most relevant criteria to assess EFS) is limited to
historical and current information. Over time, however, a supplier’s profitability, cash
flow, liquidity and solvency and therefore its economic and financial capacity to
deliver the contract can change.

2.4.4 It is therefore important that Contracting Authorities use the information available in
such a way as to provide as accurate a picture as possible of the bidder’s economic
and financial capacity to deliver the contract.

2.4.5 When Contracting Authorities use financial metrics and ratios, they should set out
bands for each metric or ratio at which a bidder would normally be classed high,
medium or low risk. Bidders should be able to see their risk classifications as they
complete their financial assessments and offer a written explanation as to why
different risk classifications may be more appropriate. Examples of such explanations
include but are not limited to:
 Improvements in a bidder’s EFS due to the sale of a business or raising of
additional capital since the last accounting reference date (but prior to the tender
submission date);
 Non-underlying charges or circumstances which are one-off in nature and not
expected to repeat themselves; and
 Adoption of new accounting policies.

1 Regulations 60 (6), (7) and (8), Public Contracts Regulations 2015

2 Financial statements should be provided in English
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2.4.6 A Contracting Authority should take such explanations into consideration in its
assessment of a bidder’s EFS. A Contracting Authority can share EFS assessments
with another government body.

2.4.7 Where there has been a public announcement of an event or other change in
circumstances affecting a bidder, a Contracting Authority may seek to calculate
proforma ratios based on the event or change of circumstances. This should be
considered in the light of circumstances at the time and would normally only be
appropriate where updated figures are available from the bidder or a reputable
independent source or can be estimated with reasonable certainty3. The Contracting
Authority should explain how it has derived the proforma ratios and give a bidder the
right to explain in writing why application of a different risk classification would be
more appropriate before using the proforma ratios as a basis for its appraisal of EFS.
Examples of changes in circumstances in which use of proforma ratios might be
appropriate include but are not limited to:
 The announcement of an acquisition or a change of control;
 The declaration or payment of large dividends or other distributions; and
 Publicly announced interim or final results or profits warnings.

2.4.8 A Contracting Authority should specify in advance the thresholds at which it may
eliminate a bidder from a procurement. Such thresholds may be linked to the risk
rating on a single financial metric or ratio or to a combination of risk ratings across
multiple financial metrics or metrics or ratios. Thresholds must be transparent,
objective and proportionate to the requirement under procurement.

2.4.9 A Contracting Authority may allow bidders to proceed despite being classified overall
as medium or high risk subject to agreeing a set of risk mitigations acceptable to the
Contracting Authority. Such mitigations may include but should not be limited to:
 Enhanced contract management and financial monitoring procedures, which may
include additional obligations or Financial Distress Events;
 Restrictions on the bidder’s business and/or its ability to make distributions or
lend money to other group members if it wins the contract; or
 The provision of a collateralised cash deposit, guarantee or performance bond.

2.4.10 A Financial Viability Risk Assessment Tool is available which can be completed by
individual bidders. The model automatically calculates a series of financial ratios and,
subject to the insertion of the desired individual ratios and thresholds, can generate
potential risk bands by ratio for each bidder subject to override by the Contracting
Authority as set out above. Input of information should be checked by the Contracting
Authority back to the source material provided by the bidder.

3If an exact figure cannot be estimated but it can reasonably be ascertained to be above (or below) a particular amount and
use of any figure above (or below) that amount would produce a similar outcome in the appraisal of EFS, the Authority may
use that amount as the basis for the proforma.
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2.4.11 The bidder’s EFS is assessed at the selection stage of a procurement but may be
revisited if there are any concerns subsequently. It is good practice to monitor any
changes to the EFS of bidders in the case of a long procurement.

2.4.12 In any event, immediately prior to contract award for Gold and Silver potential
contracts, a Contracting Authority should confirm whether there has been any
change to a bidder’s EFS which would have resulted in its elimination if it had been
known at the time of the original assessment. If such a change has occurred, a
Contracting Authority should consider whether adequate risk mitigations (such as
those set out in Section 2.4 – ‘Demonstrating economic and financial standing’
above) can be implemented. If the EFS of a winning bidder is considered to have
deteriorated to such an extent as to pose an unacceptable risk to public services
and/or public money, the contract should not be awarded to that bidder.

2.5. Financial information required from bidders

2.5.1 Contracting Authorities are encouraged to exercise flexibility when specifying the
financial information they require from bidders.

2.5.2 Proof of a bidder’s EFS should be in accordance with Public Contract Regulations
2015, Regulations 60(6) and (7). Standard information required from a bidder would
normally comprise audited accounts for the past two years of trading (this may be
extended to three years where the criticality of the potential contract requires use of
trend analysis) and information on the structure and ownership of any group of which
it is a member. Assessments should be based on the most recent audited accounts
available even if these have not been filed. Bidders should be encouraged to provide
narrative where appropriate to reduce the need for subsequent clarifications.

2.5.3 Where audited accounts are not available, other financial information that Contracting
Authorities may use, in accordance with Regulation 60(7), to demonstrate a bidder’s
EFS includes but is not limited to:
 Parent or ultimate parent company audited accounts (if applicable);
 Guarantees and bonds;
 Bankers’ statements and references;
 Management accounts;
 Financial projections (including cash flow forecasts) and order book pipeline;
 Details and evidence of previous contracts, including contract values; and
 Other evidence of capital availability.

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2.5.4 Management accounts and financial projections should be supported at the minimum
by written representations from the Boards and/or Chief Financial Officers of bidders
and ideally by independent assurance. The acceptability of different forms of
information and assurance will depend on the criticality of the potential contract;
where the procurement is for a ‘Gold’ contract the appraisal should be supported by
audited financial statements or independent support of the bidder’s EFS.

2.5.5 A number of frequent bidders have registered with central information repositories
such as the Supplier Registration Service. In order to reduce the burden on bidders,
Contracting Authorities are encouraged to use central repositories, such as the
Supplier Registration Service and Companies House, as sources of financial
information on bidders. Contracting Authorities should check or seek confirmation
from bidders, however, that the information is the most recent available and that it
relates to the correct bidding entity, particularly in group situations.

2.5.6 Many companies have similar names or change their names. The standard
Selection Questionnaire requires bidders to submit their company registration
numbers (this may be from Companies House or an equivalent). You should check
that the company registration number has been completed and if the bidder is a UK
based company, check at Companies House that the number correlates to the
company name that the bidder has provided.

2.6. Application to groups and guarantors

2.6.1 Where a bidder is a member of a group, it may benefit from the greater financial
resources available to the group. Conversely, there is a risk that a parent could
cause a bidding subsidiary to use its financial resources to support other members of
the group or that the financial failure of another group member could trigger the
financial failure of the potential supplier as a result of their inter-connectedness. As a
result, where the procurement is for a Gold or Silver contract and the bidder is not the
ultimate parent company4 of the group, the bidder should ideally be supported by a
guarantee from the ultimate parent company3 of the group where this has sufficient
EFS. At the selection stage a commitment from the ultimate parent company to
provide such a guarantee if the bidder wins the procurement would normally be
sufficient.

2.6.2 The assessment of the bidder’s EFS should cover each of (a) the bidder and (b) any
guarantor.

4 Unless the ultimate holding company acts as a pure investor and the bidder has no direct or indirect financial or other
dependence on it in which case references to the ultimate parent company should be read as references to the highest parent
company in the group which does not act as a pure investor.
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2.7. Application to joint ventures and consortia

2.7.1 Where a Contracting Authority is considering a contract with a Joint Venture
Company (JVC) or a Special Purpose Vehicle (SPV), which may have two or more
major shareholders and which may not be adequately capitalised or have sufficient
financial strength on its own to support the risks and obligations it will assume under
the contract, the Contracting Authority should normally seek ‘joint and several’
guarantees from the major shareholders of the JVC or SPV. The purpose is to avoid
a situation in which identified risks that the Contracting Authority has transferred to
the supplier are effectively passed back to the Contracting Authority by virtue of the
JVC or SPV having insufficient EFS on its own to support those risks. A commitment
to provide such guarantees would normally be sufficient at selection stage.

2.7.2 If a Contracting Authority has accepted only ‘proportionate’ liability from each of the
shareholders (i.e. ‘several’ rather than ‘joint and several’ guarantees), then it may not
achieve full recovery if the JVC or SPV and one or more of the shareholders was to
fail.

2.7.3 Similar considerations apply in the case of consortia. Where bidders rely on the EFS
of specific consortium members within a bidding group, Contracting Authorities
should normally seek joint and several guarantees from those particular members
covering the liabilities of the entire bidding group; the assessment of EFS should then
be based on those consortium members. A commitment to provide such guarantees
would normally be sufficient at selection stage.

2.8. Application to key sub-contractors

2.8.1 In this paragraph, references to key sub-contractors means:
(a) a sub-contractor that the bidder is relying on in order to meet the Contracting
Authority’s requirement for EFS; and/or
(b) a sub-contractor that the bidder proposes will deliver the whole or a substantial
or critical part of the works or services.

2.8.2 The Cabinet Office standard Selection Questionnaire requires bidders to set out
whether they will be using sub-contractors and to include the approximate
percentage of the contractual obligations to be performed by each sub-contractor.

2.8.3 Where a bidder is relying on the financial status of a key sub-contractor in order to
meet the requirement for EFS under a procurement, the Cabinet Office standard
Selection Questionnaire requires Contracting Authorities to assess the EFS of that
key sub-contractor in addition to the bidder. The bidder should also be required to
prove to the Contracting Authority that it will have at its disposal the resources
necessary, for example by producing a commitment by the key sub-contractor to that
effect.

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2.8.4 In addition, where a bidder is proposing to use key sub-contractors to deliver the
whole or a substantial or critical part of the works or services under procurement, the
Contracting Authority should also test the EFS of those key sub-contractors prior to
contract award. The Contracting Authority should explain this, including how they will
carry out the assessment, in the Selection Questionnaire or other procurement
document. For example, the Contracting Authority may wish to apply the same tests,
may adjust the thresholds pro-rata to represent the proportion of the works or
services to be delivered by the key sub-contractor or may use a different test for key
sub-contractors.

2.8.5 If the bidder is unable to demonstrate the EFS of a key sub-contractor, the
Contracting Authority must require the bidder to replace the key sub-contractor.

2.9. Application to framework agreements and call-off

agreements
2.9.1 Where a Contracting Authority is procuring a framework agreement, it should assess
the EFS of bidders in a similar manner to the procurement of a standard contract.
The Contracting Authority procuring the framework agreement should also monitor
the ongoing EFS of suppliers on the framework agreement.

2.9.2 A Contracting Authority entering into a call off contract under a framework agreement
should undertake its own financial assessment of the bidders’ financial capacity to
deliver against the requirements specific to the call-off contract.

2.10. Application to construction projects and other special

cases
2.10.1 The financial assessment tests set out in this Guidance Note are designed to test the
EFS of bidders at the selection stage of a procurement. They do not test the
deliverability of bidders’ proposed solutions which may need to be evaluated at the
assessment stage. It is typical, in construction projects and other special cases, to
ask bidders to provide financial models of their proposed solutions as part of their
bids. The financial robustness of these models should then be tested in evaluating
the deliverability of bidders’ solutions. Such models could cover, for example, the
amount of finance required, its sourcing and the ability to mitigate any adverse
contingencies.

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2.11. Use of credit ratings and credit scores

2.11.1 Credit ratings issued by major credit rating agencies (such as Moodys, Standard and
Poors and Fitch) generally provide a good, but not infallible, indication of a bidder’s
EFS. A comparison of the credit ratings issued by different agencies is set out at
Appendix IV; note in particular the difference between ‘investment grade’ and ‘non-
investment grade’ (popularly known as junk). However, the cost of such ratings
(which is paid by the companies being rated) means that they are generally limited to
larger bidders.

2.11.2 Contracting Authorities should not use the lack of a credit rating or of a minimum
credit rating as a reason to eliminate a bidder; other financial ratios should also be
considered.

2.11.3 Credit ratings should be distinguished from the credit scores issued by credit scoring
agencies such as Company Watch, Dun & Bradstreet and Experian. Credit scores
are based on algorithms; while they provide a predictive indication, their usefulness is
limited by their dependence on backwards-looking published financial information
which can be out of date.

2.12. Support
2.12.1 Where they have questions or issues, Contracting Authorities are encouraged to
consult with colleagues in the Complex Transactions Team
([email protected]) and/or Markets and Suppliers Team
([email protected]) in Cabinet Office and with other
Contracting Authorities.

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3. Mitigating Financial Risk

3.1. Introduction
3.1.1 This section reviews ways to mitigate risks arising from a bidder’s EFS which have
been identified at the procurement stage. It also reviews ways to manage changes to
a supplier’s EFS which may occur over time during the life of the contract.

3.2. Insurance
3.2.1 Employers’ Liability Insurance is generally required by law to cover employees and
many insurers incorporate it into their business insurance policies.

3.2.2 Public Liability Insurance provides cover where a customer, contractor or member
of the public is injured and the service provider is at fault. This is often combined with
Employers’ Liability Insurance.

3.2.3 Professional Indemnity Insurance is typically required to cover the provision of

professional services such as financial services or IT consultancy. It may be required
if advice is being provided to customers, if data belonging to a customer is being
handled or the service provider is responsible for a customer’s intellectual property.

3.2.4 Levels of cover: A Contracting Authority will typically wish to specify the level of
insurance cover required; the Authority should therefore formulate its intentions
before commencing a procurement.

3.2.5 A blanket approach to levels of cover should be avoided. The level of cover should
be based on the risk inherent in the contract under procurement. Adopting a blanket
approach can create unnecessary expense and friction for small businesses which
do not trade regularly with the public sector.

3.2.6 Contracting Authorities should therefore be proportionate in their specification of

insurance requirements having appropriate regard to the balance of risk and value for
money in setting the level of cover required. Contracts should be considered on an
individual basis.

3.2.7 Unless the employer is exempt, Employers’ Liability Insurance minimum cover of
£5m is fixed by law.

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3.2.8 If at the bidder selection stage a bidder does not hold the level of insurance cover
required, an undertaking to secure the cover if it should be awarded the contract
should normally be sufficient. It is not necessary at the bidder selection stage to insist
that the cover be in place.

3.3. Guarantees
3.3.1 Guarantees and bonds can be either performance or financial guarantees, or a
hybrid of both. They only crystallise when a supplier has failed to perform or to pay a
sum of money due to the Contracting Authority. As such, they provide a remedy once
a supplier has failed to deliver the works or service rather than directly supporting
performance of the contract.

3.3.2 Under a guarantee, another party (the guarantor) undertakes to fulfil the terms of the
contract (a performance guarantee) and/or provide financial compensation to the
Contracting Authority (a financial guarantee) if the contract is not fulfilled or a sum of
money not paid.

3.3.3 Where a potential supplier’s EFS appears lower than the thresholds required,
Contracting Authorities should ask it to procure a guarantee from a guarantor with
greater EFS or alternative means of support. It is important that any guarantor has
adequate assets and is an entity of substance as a guarantee is only as good as the
EFS of the entity providing it (see also Section 2.6 ‘Application to groups and
guarantors’ above). An assessment of the guarantor’s EFS will need to be
performed. Contracting Authorities should ensure that any guarantee will survive a
change of control of the guarantor or that a mechanism exists to ensure that
appropriate alternative arrangements are in place if necessary.

3.3.4 A guarantee can be provided by a member of the supplier’s group or by a bank or

insurance company. The latter would normally provide a financial guarantee where
the guarantor agrees to indemnify the Contracting Authority against specific financial
losses, liabilities and expenses incurred if the supplier defaults on its contractual
obligations. These guarantees may be less advantageous, assuming the guarantor
remains solvent, than a performance guarantee from the supplier’s parent company
or another company in the group which obliges the guarantor to perform the contract
if the supplier fails to do so (which is what the Contracting Authority ultimately wants).

3.4. Bonds
3.4.1 The financial markets can provide a variety of alternative financial instruments to
protect customers. Since these can be expensive and their cost is likely to be
reflected in bidders’ tenders, it is generally preferable to seek a parent company bond
or guarantee first where this is available and credible.

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3.4.2 A performance bond can provide some compensation if the supplier is proven to
have defaulted on its obligations. It is usually provided at contract award, for an
agreed percentage of the total contract value until its expiry date. A performance
bond will not of itself ensure that contracts are carried out efficiently and to time, but it
will be an additional incentive on the supplier to perform well.

3.4.3 Conditional bonds can usually only be called on (invoked) following a serious
breach by the supplier (including becoming insolvent, which would normally allow the
Contracting Authority to terminate the contract). These bonds provide a third-party
incentive to the supplier not to default under a contract it has entered into. They also
provide compensation to the Contracting Authority where there is a proven default.
They may be required where there are identifiable risks of default by the supplier,
subject to value for money considerations.

3.4.4 On-demand bonds include within their terms and conditions the trigger and
mechanism for calling on them. These are expensive and therefore more onerous for
the supplier; they should typically only be used for high risk and/or high value
projects where the costs and/or consequences of default by the supplier are high.
They can be called on at the sole discretion of the customer, i.e. there may be no
need to establish that the contract has been breached; if the agreed conditions for
calling are met, the payment must be made.

3.4.5 Contracting Authorities should seek professional advice on the best choice, use and
drafting of bonds. In particular, they should be used proportionately; they are
burdensome requirements for small value contracts and their costs are likely to be
reflected in tenders. Performance bonds and sureties are often used in construction
contracts where there is an active private market in the provision of such bonds and
where performance can more easily be measured; they would not normally be used
to support services contracts. Other common protection mechanisms used in
construction projects include retention arrangements and project bank accounts.

3.5. Financial Distress Events

3.5.1 The Model Services Contract contains a set of standard Financial Distress Events or
triggers. These should be included in all new critical and important contracts (‘Gold’
and ‘Silver’ contracts). Their purpose is to provide a Contracting Authority with an
early warning signal of a supplier’s possible future financial distress and give an
Authority the time and opportunity to investigate and take further action if required.

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3.5.2 The Model Services Contract also contains a list of Financial Distress Events based
on the principal financial indicators or metrics used to assess bidders’ EFS at the
procurement stage. The more important of these metrics should normally be included
in Gold and Silver contracts. Contracting Authorities should also consider whether to
include any additional Financial Distress Events to reflect the particular
circumstances of the requirement under procurement.

3.5.3 Financial Distress Events should generally be applied to each of (a) the supplier, (b)
any guarantor, (c) any key sub-contractors and (d) ‘monitored suppliers’. Monitored
suppliers would normally be limited to key members of the supplier’s group on which
the supplier depends [financially or to provide a substantial or critical part of the
works or services].

3.5.4 Suppliers of Gold and Silver contracts should be required to warrant to the
Contracting Authority, on entering into a contract, that no Financial Distress Event or
any matter which could cause a Financial Distress Event has occurred and/or is
subsisting4. Standard wording is included in the Model Services Contract.

3.5.5 If a Financial Distress Event is triggered, a Contracting Authority should promptly

discuss the position with the supplier. Subject to the detailed mechanism set out in
the contract, where the supplier satisfies the Authority that it is a false alert and/or
that it has the necessary plans in place to manage the situation, it is appropriate for
the Authority not to pursue its full rights, subject to agreeing any enhanced
monitoring or other conditions the Authority deems appropriate.

3.5.6 If a Contracting Authority remains concerned that the supplier could be entering
financial distress, it should actively pursue the situation. See Guidance on Corporate
Financial Distress for further assistance.

3.6. Other methods to mitigate financial risk

3.6.1 Risk mitigations should be proportionate to the risk identified and the inherent
criticality of the contract.

3.6.2 Contract management and monitoring procedures should help ensure that
contractual services are delivered in accordance with the terms and conditions of the
contract. Active and thorough contract management is essential; monitoring reports
provide the basis for deciding whether action should be taken if there is a specific
performance issue. In many cases the contract will also contain specific financial
(service credit) and non-financial (correction plan) remedies in the event of poor
performance.

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3.6.3 Step-in rights allow a Contracting Authority to take over some or all of a supplier’s
contractual obligations for a temporary period to rectify a problem (usually a major
performance failure), after which control is returned to the supplier. A trigger could be
where a failure by the supplier causes the Contracting Authority to be in breach of a
statutory duty where the Contracting Authority has no option but to assume control of
the service in order to remedy the statutory breach. A permanent replacement
supplier cannot be appointed under these measures; that would require a fresh
competition in accordance with applicable procurement law. The Model Services
Contract contains standard step-in rights.

3.6.4 Escrow arrangements can be used, where appropriate, to protect critical software
and technology assets. Escrow services are provided by neutral third party escrow
and verification specialists. Risk is mitigated by ensuring the Contracting Authority
has access to source code and other proprietary information needed to maintain
technology should the service provider go out of business or fail to provide support.
The trusted third party escrow specialist will securely hold the source code and
release it under specific contractual conditions.

3.6.5 Whether an escrow arrangement is entered into and who bears the cost5 is subject to
agreement between the parties. Escrow arrangements should not be required for
open source software since the source code would normally be provided with the
software.

3.6.6 Suppliers of Gold (critical) contracts and certain other suppliers should be required to
provide resolution planning information to allow Contracting Authorities to
understand better the potential impact of a supplier’s insolvency. This should enable
Contracting Authorities to work more closely with suppliers to develop mitigations to
protect short-term service continuity together with plans for the accelerated transfer
of responsibility for service provision to protect longer-term service continuity. Further
details are set out in Resolution Planning guidance.

5 These arrangements normally attract charges/fees.

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4. Monitoring the Economic and Financial

Standing of Suppliers following Contract
Award

4.1. Background
4.1.1 The EFS of suppliers, and hence the risk of their financial failure, can deteriorate
after procurement, either suddenly (for example because of the loss of a major
contract) or over time. Where a supplier’s EFS declines, there is often a heightened
risk of a decline in performance under the contract. In the relatively rare case that a
supplier becomes insolvent, there is a significant risk that services may be
interrupted or terminated, whether because of a lack of liquidity to maintain them,
loss of key staff or other reasons.

4.1.2 Early recognition of a supplier’s declining EFS or the risk of its failure may help
Contracting Authorities avert or be better prepared to deal with such under-
performance or failure as it arises limiting the impact on potentially critical public
works and services. Contracting Authorities should therefore monitor the EFS of their
key suppliers.

4.2. Principles
4.2.1 Contracting Authorities should identify their key suppliers and monitor their EFS6.

4.2.2 Monitoring should reflect the criticality of the contract and, where appropriate, should
cover not just the contractual Financial Distress Events (or their equivalent) but take
a wider view of the supplier’s business. The focus should primarily be on liquidity.

4.2.3 Where no Financial Distress Event has been notified, boards of suppliers of critical
(Gold) contracts should provide formal annual confirmations that no Financial
Distress Event or any matter which could cause a Financial Distress Event has
occurred7.

6 The overall EFS of Strategic Suppliers to Government is monitored by the Cabinet Office Markets & Suppliers Team
7 Standard wording is included in the Model Services Contract.
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4.2.4 Where monitoring and follow-up suggests a raised level of concern, contract
managers should ensure their contingency plans are up-to-date and consider
whether any further action or enhanced monitoring is required.

4.3. Identifying and monitoring key suppliers

4.3.1 Contracting Authorities should identify their key contracts and suppliers using the
Contract Tiering Tool which categorises contracts between ‘Gold’, ‘Silver’ and
‘Bronze’ based on their criticality. Key suppliers include all suppliers of critical (Gold)
contracts or important (Silver) contracts. Contracting Authorities should also consider
whether any other suppliers should also be regarded as key suppliers.

4.3.2 It can be difficult for Contract Managers involved in the day-to-day management and
monitoring of service under a contract to stand back and appraise a supplier’s EFS;
there is also a risk of ‘optimism bias’. Where practicable, an independent team or
function should therefore undertake first level monitoring. Several Departments ask
their Finance function to undertake this role.

4.3.3 The EFS of all suppliers of ‘Gold’ and ‘Silver’ contracts and any other key suppliers
should be reviewed at least once per year. EFS should be a standing item on the
agenda of supplier relationship meetings. Reviews should normally take place
following publication of the supplier’s statutory accounts and, in the case of Gold
contracts, receipt of the annual statement of compliance. In the case of publicly
quoted suppliers interim reviews may also be appropriate following publication of
interim results. Where the contract provides for more frequent (e.g. quarterly) testing
of Financial Distress Events, the monitoring frequency should adopt the same
pattern. Any key supplier considered to be at heightened risk of failure should be
monitored more frequently.

4.3.4 Monitoring teams should establish ‘alert’ systems under which they are immediately
informed, in respect of key suppliers, of:
 any stock exchange announcements (where suppliers are quoted);
 press articles commenting on a supplier’s profitability or financial standing;
 any movements in suppliers’ credit ratings (where suppliers have formal credit
ratings); and
 any drop in Dun & Bradstreet and/or Company Watch H scores below standard
financial health levels (10 for D&B score and 25 for the H score).

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4.3.5 The Markets & Suppliers Team in the Cabinet Office currently monitors the overall
financial health of Strategic Suppliers to Government. Subject to observing any
applicable confidentiality obligations, the Markets & Suppliers Team should regularly
share information on the EFS of Strategic Suppliers with the relevant Contracting
Authorities. For their part, Contracting Authorities should liaise closely with the
Markets & Suppliers Team and make them aware of any relevant information they
receive.

4.4. Coverage
4.4.1 Monitoring of key suppliers should cover not just the contractual Financial Distress
Events but take a wider view of a supplier’s business and financial health and the
level of risk. Although suppliers can collapse suddenly and unexpectedly, declines in
financial health typically occur over a longer period as a result of changes in the
market and/or business performance which then lead to a longer-term solvency
problem. It is therefore helpful to be aware of the wider business context and
performance metrics, the trends over time and non-financial indicators.

4.4.2 Where a supplier is a member of a group of companies, financial monitoring should

cover the supplier, any guarantor or monitored supplier specified in the contract and,
if this is not the ultimate holding company, the ultimate holding company. Exceptions
to this would be where the supplier and/or any guarantor have been deliberately ring-
fenced, operationally and financially, from the remainder of the group or where the
ultimate holding company acts as a pure investor (as in the case of a private equity
investor for example) and the supplier and parent company guarantor have no other
financial dependence on the ultimate parent company in which case references to
the ultimate parent company should be read as references to the highest parent
company of the ring-fenced entity or the highest parent company in the group which
does not act as a pure investor.

4.4.3 The Contracting Authority should also take whatever steps are appropriate to monitor
the EFS of key sub-contractors.

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4.5. The importance of access to liquidity

4.5.1 In terms of immediate risk, lack of access to liquidity is the typical cause of financial
failure. It is therefore important to understand a supplier’s, or a supplier group’s,
funding strategy and the nature of any borrowing arrangements. Relevant questions
include:
 Are its existing borrowing facilities committed or can they be withdrawn by the
lender?
 When do the existing facilities mature and what plans does the supplier or its
group have to repay or replace them (where maturing facilities need to be
replaced, most companies start to do this at least 12 – 18 months prior to
maturity)?
 How much borrowing headroom do the facilities provide against peak future
borrowing requirements and how will the supplier manage any pinch points?
 Has the supplier or its group provided security to its lenders?
 How tightly drawn are the covenants in the facilities? How much covenant
headroom is there?

4.5.2 Not all of this information is readily available in the public domain; some suppliers
(particularly quoted suppliers) may be reluctant to provide details of covenants and
headroom for example. Contracting Authorities should consider whether their
reluctance to provide such information stems from genuine concerns over
commercial confidentiality or potential issues in the supplier’s financial position and
prospects.

4.5.3 Set out in ‘APPENDIX V – Potential indicators of future financial distress’ is a non-
exhaustive list of potential indicators of future financial distress. Note that while the
presence of an indicator may give rise to concern, it should not be assumed
inevitably to lead to financial distress.

4.6. Access to forward looking information

4.6.1 The limitation of using published information is that it is backward-looking and can
often be a year or more out of date. Monitoring should therefore include access to
forward-looking information where possible. In the case of publicly quoted suppliers,
the share price performance relative to its peers or a relevant stock market index can
provide a useful indication of investor sentiment towards the company. The degree
of shorting of a supplier's shares can also be useful; where this exceeds 5% of a
supplier’s issued share capital, it would suggest significant divergence in investors’
views over the company’s future profitability or financial position, possibly as a result
of adverse information about its prospects leaking into the market.

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4.6.2 In the case of private suppliers which are not members of a publicly quoted group, it
may be appropriate to seek access to forward-looking information such as financial
projections or a simplified business plan. Many suppliers will provide this information
to their banks as a matter of course to support their credit lines so will have a
standard pack available on request. Where a private supplier falls below key
parameters (a Company Watch H score of 25 or a Dun and Bradstreet score of 10),
reassurance should be sought from the supplier about its financial position and
prospects.

4.6.3 Suppliers which are publicly quoted (or part of publicly quoted groups) are generally
very reluctant to provide access to forward-looking information as such information
may be price sensitive. Where analyst research reports are available, these provide a
view on investors’ expectations of a supplier’s future performance (the most useful
reports are typically those issued by a supplier’s retained stockbroker). Note however
that these can only ever represent a third-party view, that such reports are written
without access to the supplier’s internal budget and forecasts, that they cannot be
relied upon and that they are written for the benefit of investors, not customers.

4.6.4 Contracting Authorities must take legal advice or consult Cabinet Office Markets &
Suppliers Team ([email protected]) prior to accepting price
sensitive information and becoming insiders because of the obligations that this
status can create.

4.7. Annual confirmation of compliance

4.7.1 The Model Services Contract provides that Suppliers should promptly notify a
Contracting Authority following the occurrence of a Financial Distress Event or any
matter which could cause a Financial Distress Event. Where no Financial Distress
Event or any matter which could cause a Financial Distress Event has been notified,
boards of suppliers of critical (Gold) contracts should provide an annual confirmation
in writing to the Contracting Authority that no Financial Distress Event or any matter
which could cause a Financial Distress Event has occurred and/or is subsisting.
Standard wording is included in the Model Services Contract.

4.7.2 Strategic Suppliers to Government and members of their groups should additionally
be required to report by exception to the Cabinet Office Markets and Suppliers Team
where they are unable to provide the confirmation. Standard wording is included in
the Model Services Contract.

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4.8. Follow up
4.8.1 Whether or not a review indicates any concerns, it should be discussed promptly with
the contract manager. Any concerns should normally then be discussed with the
supplier and reassurance sought; it is good practice to hold at least an annual
meeting with key suppliers to discuss their financial health and strategy.

4.8.2 Where financial monitoring and follow-up suggest a raised or continuing level of
concern, contract managers should ensure their contingency plans are up-to-date
and consider whether any further action or enhanced monitoring is required. Any
concerns and actions should be raised with a senior business owner at an early
stage.

4.9. Information sources and support

4.9.1 A list of standard information sources is set out in ‘APPENDIX VI – Tools and
Information sources’ and a framework for the provision of external consultancy
support is expected to be put in place later this year.

4.9.2 Subject to observing any confidentiality obligations, information and best practice
should be shared between Contracting Authorities. The Markets and Suppliers Team
in the Cabinet Office acts as a Centre of Excellence for Financial Monitoring; it is
contactable on Team [email protected].

4.9.3 It is good practice to use an internal RAG rating system to monitor the EFS of key
suppliers. Red ratings should normally be set at the levels of the Financial Distress
Events in the relevant contract(s). Amber ratings should be set by individual
Contracting Authorities.

8 A ‘Best Practice’ network is also planned.

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APPENDIX I – Standard Financial Ratios

This Appendix provides guidance on the standard ratios and metrics that should be used
when assessing the economic and financial standing (EFS) of bidders and suppliers.

1. Terminology: The terms referred to in this paper are those used by UK companies in
their financial statements and are mostly available on the face of the Balance Sheet,
Income Statement and Statements of Cash Flow. Where the entity is not a UK company,
the corresponding items should be used even if the terminology is slightly different (for
example a charity would refer to a surplus or deficit rather than a profit or loss).

2. Groups: Where the entity is the holding company of a group and prepares consolidated
financial statements, the consolidated figures should be used.

3. Foreign currency conversion: In a procurement situation the Contracting Authority

should specify what exchange rate to use to convert amounts denoted in foreign
currency to Sterling. In some tests, where both the numerator and denominator are
expressed in the same foreign currency, no conversion may be required. Where
conversion is required, amounts should generally be converted either at current
exchange rates (e.g. the rate prevailing at the date of issue of the Selection
Questionnaire) or at the exchange rate in force at the relevant date for which the financial
ratio or metric is being calculated.

4. Treatment of non-underlying items: Ratios should generally be based on the figures in

the financial statements before adjusting for non-underlying items. Where this produces
other than a low risk outcome, Contracting Authorities should permit adjustment for non-
underlying items, subject to satisfying themselves that the items are material and out of
the ordinary course, on the basis that this is likely to provide a better representation of
underlying performance.

Subject to reserving the right to do so, a Contracting Authority may also adjust for non-
underlying items which are material and out of the ordinary course where this would
move the categorisation to a higher risk banding provided this is explained in the
Selection Questionnaire or other procurement document, that it discloses the proposed
adjustments to the bidder, allows the bidder adequate time to respond and appropriately
considers any representations the bidder wishes to make.

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5. Accounting periods of other than 12 months: Where metrics are measured for a
period rather than at a specific date (for example, operating profit), they should generally
be based on figures for periods of 12 months to allow for potential seasonality.
Appropriate adjustments should be made where necessary. Contracting Authorities
should discuss the basis of the adjustments with their Finance Teams.

6. Post balance sheet events: Bidders may draw attention to post balance sheet events in
explaining why application of a different risk threshold may be more appropriate than that
generated by the ratios. Similarly, Contracting Authorities may adjust for post balance
sheet events in preparing proforma ratios (see Paragraph 2.4.7).

7. Qualified accounts: Where the Independent Auditor’s Opinion on the entity’s financial
statements has been qualified (either due to not being able to obtain sufficient evidence
or if the auditor concludes that the financial statements are not free from material
misstatement) or if the Auditor’s Opinion contains an emphasis of matter, Contracting
Authorities should review the qualification or emphasis and decide how to proceed.
Additional assurance may be required to confirm the entity’s EFS. Particular care should
be taken where the qualification or emphasis relates to whether the entity is a going
concern.

The methodology for assessing EFS should be clearly described and any minimum financial
requirements clearly stated in the Selection Questionnaire or other procurement document.
Where bidders are asked to insert figures in a response or model, a copy of the underlying
financial statements or other document supporting those figures should be sought so that
they can be checked if required. A check should always be performed on the winning bidder.
Where the procurement relates to a critical or important (Gold or Silver) contract, checks
should be performed on all bidders at the bidder selection stage to avoid the risk of later
damage and delay to the procurement.

The assessment should normally include as a minimum the standard financial metrics and
ratios set out below. The list is not exhaustive and should be tailored to the particular
requirement under procurement. Any ratios used should be transparent, objective,
proportionate and non-discriminatory. Where a bidder’s ratio score results in a High Risk
classification, there is an opportunity within the Financial Viability Rating Assessment
template for the bidder to provide explanations. If an alternative tool is used the same
opportunities should be provided to bidders.

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Metric 1 – Turnover Ratio

Turnover Ratio = Bidder Annual Revenue / Expected Annual Contract Value

Definition
Revenue should be shown on the face of the Income Statement in a standard set of financial
statements. It should exclude the entity’s share of the revenue of joint ventures or associates.

Interpretation
The Turnover Ratio is used to understand how large the contract is compared to the annual
revenue of a bidder for the contract. A larger number might suggest that the bidder can
accommodate the contract more easily and be better able to deliver the contract.

Benchmark
The Public Contract Regulations 2015 (Regulation 58.9) permit Contracting Authorities to
require a minimum annual turnover of up to twice the estimated contract value (save where a
higher figure can be justified by reference to the special risks attaching to the nature of the
works, services or supplies). Turnover thresholds should be set at a reasonable level so as to
provide assurance of the capacity of the bidder to deliver the goods and services required,
without imposing inappropriate and unfair barriers to smaller, particularly social sector,
suppliers. Bidders should normally not be eliminated on the basis of the Turnover Ratio
alone.

The Turnover Ratio is not relevant to the procurement of multi-supplier frameworks.

Potential mitigations
Where application of the test generates a ratio which would fall into the medium or high risk
band, potential mitigations could include:
 Extension of the test to the bidder’s wider group where the bidder is part of a group and
the bidder is supported by a parent company guarantee; or
 Inclusion of new contracts won by the bidder since the publication of its financial results
or the full impact of which is not reflected in the financial statements used for the
assessment.

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Metric 2 –Operating Margin

Operating Margin = Operating Profit / Revenue

Definition
The elements used to calculate the Operating Margin should be shown on the face of the
Income Statement in a standard set of financial statements. Figures for Operating Profit and
Revenue should exclude the entity’s share of the results of joint ventures or associates.
Where an entity has an operating loss (i.e. where the operating profit is negative), Operating
Profit should generally be taken to be zero.

Since Operating Margin can vary, the test should normally be based on the higher of (a) the
Operating Margin for the most recent accounting period and (b) the average Operating
Margin for the last two accounting periods.

Interpretation
Operating Margin is a measure of an entity’s profitability. A higher ratio would normally
suggest, other things being equal, that the entity’s business is more sustainable and able to
withstand any change in business and financial circumstances. Conversely, a low ratio may
raise doubts over the sustainability of the business and hence the entity.

Benchmark
See standard ratios by sector in ‘APPENDIX II – Interpreting standard financial metrics’.

Potential mitigations
The Operating Margin may not be representative of a bidder’s future profitability and hence
sustainability. It may also not reflect a bidder’s mission. Where application of the test
generates a ratio which would fall into the medium or high risk band, potential mitigations
could include:
 Adjustment for any one-off costs or expenses that unduly affected the Operating Margin
for the period(s) under consideration and are unlikely to be repeated to the same extent
in future years;
 Adjustment for profitable new business won or loss-making business closed since the
publication of its financial results or the full impact of which is not reflected in the financial
statements used for the assessment; or
 Recognition that the Operating Margin may not be an appropriate indicator of
sustainability where, for example, the bidder is a charity or other non-profitmaking
organisation with a mission to subsidise provision of services.

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Metric 3(A) – Free Cash Flow to Net Debt Ratio

(Metrics 3(A) and 3(B) are alternative measures. Metric 3(A) is more relevant to capital
intensive sectors and Metric 3(B) to less capital intensive sectors.)

Free Cash Flow to Net Debt Ratio = Free Cash Flow / Net Debt

Definition
Free Cash Flow = Net cash flow from operating activities – Capital expenditure

Capital expenditure = Purchase of property, plant & equipment + Purchase of intangible

assets

Net Debt = Bank overdrafts + Loans and borrowings + Finance leases + Deferred
consideration payable – Cash and cash equivalents

The majority of the elements used to calculate the Free Cash Flow to Net Debt Ratio should
be shown on the face of the Statement of Cash Flows and the Balance Sheet in a standard
set of financial statements.
 Net cash flow from operating activities: This should be stated after deduction of
interest and tax paid.
 Capital expenditure: The elements of capital expenditure may be described slightly
differently but will be found under ‘Cash flows from investing activities’ in the Statement
of Cash Flows; they should be limited to the purchase of fixed assets (including
intangible assets) for the business and exclude acquisitions of other companies or
businesses. The figure should be shown gross without any deduction for any proceeds of
sale of fixed assets.
 Net Debt: The elements of Net Debt may also be described slightly differently and
should be found either on the face of the Balance Sheet or in the relevant note to the
financial statements. All interest bearing liabilities (other than retirement benefit
obligations) should be treated as borrowings as should, where disclosed, any liabilities
(less any assets) in respect of any hedges designated as linked to borrowings (but not
non-designated hedges). Borrowings should also include balances owed to other group
members.

Deferred consideration payable should be included in Net Debt despite typically being
non-interest bearing.

Cash and cash equivalents should include short-term financial investments shown in
current assets.

Where an entity has net cash (i.e. where application of the formula would produce a
negative figure), the outcome of the test should be treated as ‘Low Risk’.

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Interpretation
An entity’s free cash flow represents the cash generated from its operations which is
available for other purposes after ongoing capital expenditure. The Free Cash Flow to Net
Debt Ratio effectively shows the proportion of its outstanding net debt (debt less cash), which
it could pay off in a year if all its free cash flow went towards repaying debt and is a measure
of the bidder’s leverage. A high ratio would normally indicate, other things being equal, that
an entity is better able to pay back its debt and/or may be able to take on more debt if
necessary. Conversely, a low ratio may raise doubts over an entity’s ability to service its
existing debt.

Benchmark
See standard ratios by sector in ‘APPENDIX II – Interpreting standard financial metrics’.

Potential mitigations
A bidder’s free cash flow for one year in isolation may not be representative of its future
ability to generate cash. It may also have other means to service its debt or its debt may not
be due for repayment for a significant period. Where application of the test generates a ratio
which would fall into the medium or high risk band, potential mitigations could include:
 Adjustment for any one-off costs that unduly affected the free cash flow for the year
under consideration and are unlikely to be repeated to the same extent in future years; or
 Adjustment for profitable new business won or loss-making business closed since the
publication of its financial results or the full impact of which is not reflected in the financial
statements used for the assessment; or
 Adjustment for exceptionally high capital expenditure which unduly depressed the free
cash flow for the year under consideration and is unlikely to be required at the same level
in future years; or
 A bidder’s ability or plans to repay debt from sources other than the generation of free
cash flow from operations, for example through the sale of an asset or business currently
generating limited cash flow or through the use of parent company resources where the
bidder is a member of a wider group; or
 Adjustment for elements of debt or deferred consideration which are only due for
repayment in the long-term (for example beyond the maturity of the contract under
procurement) or debt which is held with other companies in the same group which is not
likely to be required to be repaid; or
 Adjustment for contingent deferred consideration to the extent that the liability is unlikely
to crystallise in practice.

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Metric 3(B) – Net Debt to EBITDA Ratio

(Metrics 3(A) and 3(B) are alternative measures. Metric 3(A) is more relevant to capital
intensive sectors and Metric 3(B) to less capital intensive sectors.)

Net Debt to EBITDA ratio = Net Debt / EBITDA

Definition
Net Debt = Bank overdrafts + Loans and borrowings + Finance leases + Deferred
consideration payable – Cash and cash equivalents

EBITDA = Operating profit + Depreciation charge + Amortisation charge

The majority of the elements used to calculate the Net Debt to EBITDA Ratio should be
shown on the face of the Balance sheet, Income statement and Statement of Cash Flows in a
standard set of financial statements but will otherwise be found in the notes to the financial
statements.

 Net Debt: The elements of Net Debt may be described slightly differently and should be
found either on the face of the Balance Sheet or in the relevant note to the financial
statements. All interest bearing liabilities (other than retirement benefit obligations)
should be included as borrowings as should, where disclosed, any liabilities (less any
assets) in respect of any hedges designated as linked to borrowings (but not non-
designated hedges). Borrowings should also include balances owed to other group
members.

Deferred consideration payable should be included in Net Debt despite typically being
non-interest bearing.

Cash and cash equivalents should include short-term financial investments shown in
current assets.

Where an entity has net cash (i.e. where Net Debt is negative), the outcome of the test
should be regarded as ‘Low Risk’.

 EBITDA: Operating profit should be shown on the face of the Income Statement and, for
the purposes of this test, should include the entity’s share of the results of any joint
ventures or associates.

The depreciation and amortisation charges for the period may be found on the face of
the Statement of Cash Flows or in a Note to the Accounts.

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Where EBITDA is negative, the outcome of the test should be regarded as ‘High risk’
unless Net Debt is also negative in which case the outcome of the test should be
regarded as ‘Low Risk’.

Interpretation
An entity’s EBITDA is a proxy for the cash flow it generates from its ongoing operations. The
Net Debt to EBITDA Ratio is often used by lenders as a measure of an entity’s ability to
service its debt. A low ratio would normally indicate, other things being equal, that an entity is
better able to pay back its debt and/or may be able to take on more debt if necessary.
Conversely, a high ratio may raise doubts over an entity’s ability to service its existing debt.

Benchmark
See standard ratios by sector in ‘APPENDIX II – Interpreting standard financial metrics’.

Potential mitigations
A bidder’s EBITDA for one year in isolation may not be representative of its future ability to
generate cash. It may also have other means to service its debt or its debt may not be due
for repayment for a significant period. Where application of the test generates a ratio which
would fall into the medium or high risk band, potential mitigations could include:
 Adjustment for any one-off costs that unduly affected EBITDA for the year under
consideration and are unlikely to be repeated to the same extent in future years; or
 Adjustment for profitable new business won or loss-making business closed since the
publication of its financial results or the full impact of which is not reflected in the financial
statements used for the assessment; or
 A bidder’s ability or plans to repay debt from sources other than the generation of cash
flow from operations, for example through the sale of an asset or business currently
generating limited cash flow or through the use of parent company resources where the
bidder is a member of a wider group; or
 Adjustment for elements of debt or deferred consideration which are only due for
repayment in the long-term (for example beyond the maturity of the contract under
procurement) or debt which is held with other companies in the same group which is not
likely to be required to be repaid.
 Adjustment for contingent deferred consideration to the extent that the liability is unlikely
to crystallise in practice.

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Metric 4 – Net Debt + Net Pension Deficit to EBITDA Ratio

Net Debt + Net Pension Deficit to EBITDA ratio = (Net Debt + Net Pension Deficit) / EBITDA

Definition
Net Debt = Bank overdrafts + Loans and borrowings + Finance leases + Deferred
consideration payable – Cash and cash equivalents

Net Pension Deficit = Retirement Benefit Obligations – Retirement Benefit Assets

EBITDA = Operating profit + Depreciation charge + Amortisation charge

The majority of the elements used to calculate the Net Debt + Net Pension Deficit to EBITDA
Ratio should be shown on the face of the Balance sheet, Income statement and Statement of
Cash Flows in a standard set of financial statements but will otherwise be found in the notes
to the financial statements.

 Net Debt: The elements of Net Debt may be described slightly differently and should be
found either on the face of the Balance Sheet or in the relevant note to the financial
statements. All interest bearing liabilities (other than retirement benefit obligations)
should be included as borrowings as should, where disclosed, any liabilities (less any
assets) in respect of any hedges designated as linked to borrowings (but not non-
designated hedges). Borrowings should also include balances owed to other group
members.

Deferred consideration payable should be included in Net Debt despite typically being
non-interest bearing.

Cash and cash equivalents should include short-term financial investments shown in
current assets.

 Net Pension Deficit: Retirement Benefit Obligations and Retirement Benefit Assets may
be shown on the face of the Balance Sheet or in the notes to the financial statements.
They may also be described as pension benefits / obligations, post-employment
obligations or other similar terms.

Where calculation of Net Debt + Net Pension Deficit produces a negative figure, the
outcome of the test should be regarded as ‘Low Risk’.

 EBITDA: Operating profit should be shown on the face of the Income Statement and, for
the purposes of this test, should include the entity’s share of the results of any joint
ventures or associates.

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The depreciation and amortisation charges for the period may be found on the face of the
Statement of Cash Flows or in a Note to the Accounts.

Where EBITDA is negative, the outcome of the test should be regarded as ‘High risk’
unless the Net Debt + Net Pension Deficit calculation also produces a negative figure in
which case the outcome of the test should be regarded as ‘Low risk.

Interpretation
Pension deficits have some similarities to debt in that they represent obligations repayable
over time on which interest accrues. An entity’s EBITDA is a proxy for the cash flow it
generates from its ongoing operations. The Net Debt + Net Pension Deficit to EBITDA Ratio
measures the scale of an entity’s debt and any pension deficit relative to the entity’s size. A
low ratio would normally indicate, other things being equal, that an entity is better able to pay
back its debt and fund its pension fund deficit and/or may be able to take on more debt if
necessary. Conversely, a high ratio may raise doubts over the sustainability of the entity.

Benchmark
See standard ratios by sector in ‘APPENDIX II – Interpreting standard financial metrics’.

Potential mitigations
A bidder’s pension deficit may not need to be paid off for many years and may be overstated
against its actuarial value. A bidder’s EBITDA for one year in isolation may not be
representative of its future ability to generate cash. It may also have other means to service
its debt or pension deficit or its debt and pension deficit may not be due for repayment for a
significant period. Where application of the test generates a ratio which would fall into the
medium or high risk band, potential mitigations could include:
 Adjustment for any one-off costs that unduly affected EBITDA for the year under
consideration and are unlikely to be repeated to the same extent in future years; or
 Adjustment for profitable new business won or loss-making business closed since the
publication of its financial results or the full impact of which is not reflected in the financial
statements used for the assessment; or
 A bidder’s ability or plans to repay debt from sources other than the generation of cash
flow from operations, for example through the sale of an asset or business currently
generating limited cash flow or through the use of parent company resources where the
bidder is a member of a wider group; or
 Adjustment for elements of debt, deferred consideration or pension deficit which are only
due for repayment in the long-term (for example beyond the maturity of the contract
under procurement) or debt which is held with other companies in the same group which
is not likely to be required to be repaid; or
 Adjustment for contingent deferred consideration to the extent that the liability is unlikely
to crystallise in practice; or
 Where the deficit in the most recent triennial valuation (as adjusted for subsequent deficit
recovery payments) is significantly lower than that shown for accounting purposes.
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Metric 5 – Net Interest Paid Cover

Net Interest Paid Cover = Earnings Before Interest and Tax / Net Interest Paid

Definition
Earnings Before Interest and Tax = Operating profit

Net Interest Paid = Interest paid – Interest received

Operating profit should be shown on the face of the Income Statement in a standard set of
financial statements and, for the purposes of this test, should include the entity’s share of the
results of any joint ventures or associates. Where the entity has an operating loss (i.e. a
negative operating profit), operating profit should generally be taken to be zero.

Interest received and interest paid should be shown on the face of the Cash Flow statement.

Where Net interest paid is negative (i.e. the entity has net interest received), the outcome of
the test should be regarded as ‘Low risk’.

Interpretation
The Net Interest Paid Cover measures how easily an entity can pay interest on its debt out of
the profits it generates from its operations, and therefore provides a measure of the entity’s
solvency. A higher number would normally indicate, other things being equal, that the entity is
better able to service interest on its debt, and/or is more likely to be able to borrow additional
money if required. Conversely, a low figure may raise doubts over an entity’s ability to service
the interest on its existing debt.

Benchmark
See standard ratios by sector in ‘APPENDIX II – Interpreting standard financial metrics’.

Potential mitigations
A bidder’s EBIT for one year in isolation may not be representative of its future EBIT. A
bidder may also have plans to repay its debt from other sources reducing the level of future
interest or the interest may be rolled up and not due for payment until a future date. Where
application of the test generates a ratio which would fall into the medium or high risk band,
potential mitigations could include:
 Adjustment for any one-off costs that unduly affected EBIT for the year under
consideration and are unlikely to be repeated to the same extent in future years; or
 Adjustment for profitable new business won or loss-making business closed since the
publication of its financial results or the full impact of which is not reflected in the
accounts used for the assessment; or

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 A bidder’s plans to repay debt, for example through the sale of an asset or business
currently generating limited profits or through the use of parent company resources
where the bidder is a member of a wider group.

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Metric 6 – Acid Ratio

Acid Ratio = (Current Assets – Inventories)/ Current Liabilities

Definition
All elements that are used to calculate the Acid Ratio are available on the face of the Balance
Sheet in a standard set of financial statements.

Interpretation
The Acid Ratio provides a measure of an entity’s ability to meet its short term liabilities. A
high ratio would normally suggest, other things being equal, that it can more easily meet its
liabilities as they fall due. Conversely, a low ratio may raise doubts over its ability to meet its
liabilities as they fall due.

Benchmark
See standard ratios by sector in ‘APPENDIX II – Interpreting standard financial metrics’.

Potential mitigations
The Acid Ratio ignores inventories and focuses just on an entity’s more liquid assets relative
to its short-term liabilities. It ignores the availability of other sources of funding with which to
pay short-term liabilities, the possibility that its inventory may be capable of swift realisation
and an entity’s ability to take credit from its suppliers. Where application of the test generates
a ratio which would fall into the medium or high risk band, potential mitigations could include:
 A bidder’s ability to raise cash through new borrowings, equity issuance, the sale of an
asset or the use of parent company resources where the bidder is a member of a wider
group;
 A bidder’s stock turn, i.e. the speed with which it can sell its inventory to raise cash; and
 The nature of the bidder’s short-term liabilities which may include creditors and accruals
not immediately due for settlement.

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Metric 7 – Net Asset Value

Net Asset Value = Net Assets

Definition
Net Assets are shown (but sometimes not labelled) on the face of the Balance sheet of a
standard set of financial statements. Net Assets are sometimes called net worth or
Shareholders’ Funds. They represent the net assets available to the shareholders. Where an
entity has a majority interest in another entity in which there are also minority or non-
controlling interests (i.e. where it has a subsidiary partially owned by outside investors), Net
Assets should be taken inclusive of minority or non-controlling interests (as if the entity
owned 100% of the other entity).

Interpretation
The Net Asset Value provides a basic view of whether an entity’s assets exceed its liabilities.
Where an entity has a negative Net Tangible Asset Value this may suggest the business and
hence the entity is less sustainable in the event of any deterioration in performance.

Benchmark
See standard ratios by sector in ‘APPENDIX II – Interpreting standard financial metrics’.

Potential mitigations
The value of an entity’s Net Assets provides a very basic assessment of its worth. Assets are
stated at accounting values which may be substantially lower than their market values,
particularly in the case of fixed assets. Many intangible assets may not be included at all.
The test provides no indication of an entity’s ability to pay its creditors as they fall due, with
no recognition of its ability to generate funds, of the funding available to an entity or of when
liabilities are due for payment.
Where application of the test would suggest medium or high risk, potential mitigations could
include:
 Considering the value of any intangible assets such as goodwill which have not been
included in the balance sheet (although the value of purchased goodwill is included in
balance sheets, the value of self-generated goodwill is not);
 Considering any other assets (for example property) which may have been included at
an undervalue;
 Considering the ability of the entity to generate EBITDA sufficient to meet its liabilities as
they fall due;
 Considering other sources of funding available to the entity.

Bidders should normally not be eliminated on the basis of the Net Asset Value test alone.

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Metric 8 – Group Exposure Ratio

Group Exposure Ratio = Group Exposure / Gross Assets

Definition
Group Exposure = Balances owed by Group Undertakings + Contingent liabilities assumed in
support of Group Undertakings

Gross Assets = Fixed Assets + Current Assets

Group Exposure: Balances owed by (i.e. receivable from) Group Undertakings are shown
within Fixed assets or Current assets either on the face of the Balance Sheet or in the
relevant notes to the financial statements. In many cases there may be no such balances, in
particular where an entity is not a member of a group or is itself the ultimate holding company
of the group.

Contingent liabilities assumed in support of Group Undertakings are shown in the Contingent
Liabilities note in a standard set of financial statements. They include the value of guarantees
and security given in support of the borrowings of other group companies, often as part of
group borrowing arrangements. Where the contingent liabilities are capped, the capped
figure should be taken as their value. Where no cap or maximum is specified, the outcome of
the test should automatically be regarded as ‘High risk’.

In many cases an entity may not have assumed any contingent liabilities in support of Group
Undertakings, in particular where an entity is not a member of a group or is itself the ultimate
holding company of the group.

Gross Assets: Both Fixed assets and Current assets are shown on the face of the Balance
Sheet

Interpretation
This test is relevant to subsidiaries and controlled entities which may have exposures (actual
or contingent) to wider group entities whose results are not reflected in the entity’s own
financial statements. The test is designed to establish whether an entity could withstand a
significant adverse event elsewhere within the group of which it is a member; such an event
could lead to the non-recovery of balances owed to it by other group members or to the
crystallisation of a contingent liability linked to the wider group (e.g. a call under a guarantee).

Where Group Exposure represents a high or uncapped percentage of an entity’s Gross

Assets, this suggests the entity is more exposed to the performance or position of other
entities within its wider group. Typical exposures arise where an entity is a member of a
borrowing group the members of which have provided cross guarantees and/or security to
the lender.
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Benchmark
See standard ratios by sector in ‘APPENDIX II – Interpreting standard financial metrics’.

Potential mitigations
The value of an entity’s Gross Assets may be a poor reflection of the size and value of the
entity. Where application of the test would suggest medium or high risk, potential mitigations
could include:
 A comparison of Group Exposure relative to the size of the bidder as measured by
Revenue or Operating profit rather than Gross Assets; and
 Inclusion within Gross Assets of the value of any intangible assets such as goodwill
which have not been included in the balance sheet (although the value of purchased
goodwill is included in balance sheets, the value of self-generated goodwill is not).

Where an entity has uncapped exposure to wider group entities, the solution is often to seek
a parent company guarantee. Other potential mitigations might include analysis of the EFS of
those other group entities to which the entity is exposed to determine whether or not the risk
of an exposure crystallising is limited (for example, an entity may be a member of a
borrowing group and act as guarantor of its parent company’s drawings under a debt facility
but the facility itself is capped or is unlikely to be drawn down).

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APPENDIX II – Interpreting standard financial

metrics

The following table sets out how to interpret the results of standard financial assessments.

How to use the table

Before you start:
1. Calculate the ratio based on the guidance in Appendix I.
2. Identify the criticality (ie Gold, Silver or Bronze) of the contract under procurement using
the Contract Tiering Tool.
3. Identify the most suitable sector (in the first column) into which the services to be
delivered under the contract fall.

Consulting the table:

4. Identify the metric you have calculated in the 2nd column.
5. Identify the relevant set of thresholds based on the contract criticality (ie Gold, Silver or
Bronze).
6. Identify the threshold into which the calculation carried out in step 1 falls.
7. The column header identifies the level of risk the supplier represents based on the metric
assessed.

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Interpreting standard financial metrics - Risk categories by Sector and Criticality of procurement
The following table should be used to determine the level of risk associated with a bidder following the application of standard financial assessments.
Important (Silver) or Critical (Gold)
Non-critical (Bronze) procurements
procurements
Sector Metric Low risk Medium risk High risk Low risk Medium risk High risk
1 1
Metric 1 - Turnover Ratio >2.0x 1.5 - 2.0x <1.5 >2.0x 1.5 - 2.0x <1.5
Metric 2 - Operating Margin N/A N/A N/A >10% 5 - 10% < 5%
Metric 3(A) - Free Cash Flow / Net Debt N/A N/A N/A > 15% 5 - 15% < 5%
Metric 3(B) - Net Debt / EBITDA < 2.5x 2.5 - 3.5x > 3.5x < 2.5x 2.5 - 3.5x > 3.5x
All sectors (save where
Metric 4 - Net Debt + Net Pension Deficit / EBITDA N/A N/A N/A < 4.0x 4.0 - 5.0x >5.0x
shown separately below)
Metric 5 - Net Interest Paid Cover > 4.0x 2.5 - 4.0x < 2.5x > 4.5x 3.0 - 4.5x < 3.0x
Metric 6 - Acid Ratio > 0.8x 0.7 - 0.8x < 0.7x > 1.0x 0.8 - 1.0x < 0.8x
Metric 7 - Net Assets > Nil > Nil > Nil > Nil > Nil > Nil
Metric 8 - Group Exposure Ratio N/A N/A N/A <25% 25 - 50% > 50%

Metric 2 - Operating Margin > 8% 3 - 8% <3% > 10% 5 - 10% < 5%

Business Process Metric 3(A) - Free Cash Flow / Net Debt N/A N/A N/A N/A N/A N/A
Outsourcing Metric 3(B) - Net Debt / EBITDA < 2.5x 2.5 - 3.5x > 3.5x < 2.5x 2.5 - 3.5x > 3.5x
Metric 4 - Net Debt + Net Pension Deficit / EBITDA N/A N/A N/A < 4.0x 4.0 - 5.0x >5.0x

Metric 2 - Operating Margin > 6% 3 - 6% < 3% > 7% 4 - 7% < 4%

Facilities Management Metric 3(A) - Free Cash Flow / Net Debt N/A N/A N/A N/A N/A N/A
and Construction Metric 3(B) - Net Debt / EBITDA < 1.0x 1.0 - 2.0x > 2.0x < 1.0x 1.0 - 2.0x > 2.0x
Metric 4 - Net Debt + Net Pension Deficit / EBITDA N/A N/A N/A < 2.5x 2.5 - 3.5x >3.5x

Metric 2 - Operating Margin N/A N/A N/A > 10% 5 - 10% < 5%
Information Technology Metric 3(A) - Free Cash Flow / Net Debt N/A N/A N/A N/A N/A N/A
and Telecoms Metric 3(B) - Net Debt / EBITDA < 3.0x 3.0 - 3.5x > 3.5x < 3.0x 3.0 - 3.5x >3.5x
Metric 4 - Net Debt + Net Pension Deficit / EBITDA N/A N/A N/A <4.5x 4.5 - 5.0x >5.0x
Notes:
(1) Maximum threshold at which exclusion is permitted by procurement law
(2) The selection of ratios and thresholds should be tailored to the circumstances of the particular procurement. For example, for very short bronze contracts it may not
be appropriate to apply a Net Debt / EBITDA ratio. For potential Gold contracts, however, more demanding thresholds may be appropriate. Contracting Authorities
should consider what is appropriate to their particular procurement and adopt a ‘Comply or Explain’ approach.
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APPENDIX III – Financial Assessment Flowcharts

Financial Testing Decision Tree Part 1 – Financial Assessment of Bidders

Is the bidder / other

Refer to other financial
entity1 in scope able to
Start No information that may be used
provide historical
[see section 2.5]
financial accounts?

Yes

Conduct Contract Tiering Analysis

[refer to Section 2.3 for additional
information]
Assess Gold
Bronze Contract
Tier
Conduct Ratio and/or Trend
Use “off the shelf” financial analysis Conduct Ratio Analysis Analysis
to find H-Score/D&B score [See Appendices I and II] Silver [See Appendices I & II]

Is the H-
Score/D&B Are ratios /
No Are ratios within
score above trends within
pre-defined
threshold? No No pre-defined
acceptable risk
acceptable risk
thresholds?
thresholds?
Can bidder provide
Yes
acceptable
additional assurance
to enable authority
No to manage risk? Yes Yes

Financial Financial
Assessment Assessment
Passed Passed Financial
Financial
Assessment Add additional assurances /
Assessment
Failed undertakings into contract
Passed
Notes
1. Other entities in scope may include the guarantor and any key sub-contractors

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Financial Testing Decision Tree Part 2 – In Contract Financial Monitoring

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APPENDIX IV – Comparison of credit ratings

issued by different rating agencies

Moodys Standard & Poors Fitch

Long-term Short-term Long-term Short-term Long-term Short-term
Aaa AAA A-1+ AAA F1+ Prime
Aa1 AA+ AA+ High grade
Aa2 AA AA
P-1
Aa3 AA- AA-
A1 A+ A-1 A+ F1 Upper
A2 A A medium
A3 A- A-2 A- F2 grade
P-2
Baa1 BBB+ BBB+ Lower
Baa2 BBB BBB F3 medium
P-3
Baa3 BBB- A-3 BBB- grade
Ba1 BB+ BB+ Non-
Ba2 BB BB investment
Ba3 BB- BB- grade
B B speculative
B1 B+ B+ Highly
B2 B B speculative
B3 B- B-
Caa1 CCC+ C CCC+ C Substantial
Not Prime risks
Caa2 CCC CCC
Caa3 CCC- CCC-
Ca CC CC Extremely
speculative
C C Default
imminent
C RD D DDD D In default
/ SD DD
/ D D

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APPENDIX V – Potential indicators of future

financial distress

Financial Non-financial

Business ● Adverse changes in the ● Unexpected resignations of key

performance / market / market structure management / High employee turnover
Operating ● Declining revenues ● Weak management or overly controlling
efficiency ● Declining profit margins CEO
● Declining Return on Capital ● Delayed filing of statutory accounts / late
Employed provision of management information
● Declining cash conversion ● Competitor gossip / market intelligence
● Public profit warnings ● Regulatory action
● Increases in creditor days / ● Declining share price / Sudden share
Delayed payments to price falls / Significant shorting of shares
suppliers ● Major adverse announcements (e.g.
● Decreases in debtor days major litigation, large contract losses, etc)
● Declining stock turnover

Liquidity / ● High / Rising net debt to ● Poor or deteriorating relationship with

Solvency EBITDA Lenders
● Declining interest cover ● Withdrawal of coverage of a supplier’s
● High / Rising gearing debts by credit insurers
● Deteriorating liquidity / ● Falls in or withdrawal of credit ratings (or
Declining headroom announcements of credit watch with
● Lending covenant breaches negative implications) by major credit
● Increasing reliance on short- agencies
term or uncommitted debt ● Company Watch H score falling below 25
● Use of non-standard financing / Dun and Bradstreet score falling below
markets 10
● Going concern qualifications in
published accounts
● Requests for payments in
advance
● Invoice discounting / Factoring
/ Other means of raising short-
term cash
● Rising pension deficits
● Rising contingent liabilities
● Cuts in / Cancelled dividends

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APPENDIX VI – Tools and Information

sources

Financial Viability Risk Assessment tool

https://www.gov.uk/government/publications/the-outsourcing-playbook

Outsourcing Playbook
https://www.gov.uk/government/publications/the-outsourcing-playbook

EU procurement Regulations (for thresholds and reference to Regulation 60(7))

https://www.ojec.com/directives.aspx

Supplier Registration Service

https://supplierregistration.cabinetoffice.gov.uk/

Companies House
https://www.gov.uk/government/organisations/companies-house

Contract Tiering Tool (KHub account required)

https://khub.net/group/gcf-community/group-library/-/document_library

Company Watch
https://www.companywatch.net/

Dun & Bradstreet

https://www.dnb.co.uk/

Model Services Contract

https://www.gov.uk/government/publications/model-services-contract

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