Vetting an LSP? Ask it to show you the money

When companies go to choose a logistics service provider (LSP), they tend to give a lot of weight to factors like price, capabilities, experience, management depth, and so forth. What sometimes gets overlooked in the process is the LSP's financial health.

Unfortunately, that's something a prospective client can't afford to skim over. While it might feel awkward to question a candidate about its financial stability, this is an essential part of the due diligence. For one thing, you want assurances that the provider will be around for the long term. For another, if you're signing a sizable contract (as is common today), it's important to ascertain that the LSP has adequate financial resources to provide the support and services you require.

How do you go about investigating a candidate's financial health? If the provider is a publicly held company, it's a relatively straightforward matter. Its financial statements will be a matter of public record and therefore, readily available for your review.

If the prospective partner is a privately held concern, however, it can be a bit tougher. While some will furnish serious prospects with audited financial statements before the final agreement is signed (and then every year thereafter), others may be extremely reluctant to provide financial data. If you encounter resistance, persist until you get satisfactory answers. A provider that is financially healthy, responsible, and capable of handling the business will find an acceptable method of demonstrating that.

Although outsourcing will always carry some risk, there are a number of steps you can take to minimize your company's exposure. What follows are some suggestions:

1. Insist on inspecting audited financial statements—particularly documents like profit and loss statements and balance sheets that will give you an idea of the LSP's net income, net worth, and debt load. Don't settle for banking information. While banking data can sometimes be helpful, it's not a reliable indicator of financial health. Many times, banks will only release vague details that provide an incomplete picture at best of the provider's finances.
2. Be sure to have the statements reviewed by qualified financial specialists. If that responsibility is left to logistics professionals with no training in finance, important clues could be overlooked.
3. Check on the reputation of the auditing firm used by the provider.
4. If funds are to be advanced (for example, if the LSP will be providing freight payment services), be sure they won't be co-mingled with the provider's general operating funds. Also, find out what types of investments the provider is making (with your money). Poor investment choices could result in the LSP's failure to pay a carrier, for example, leaving you on the hook for a bill for which you've already advanced the money to the LSP.
5. Determine if bond coverage is available. If so, make sure the bonds adequately cover the risks. Some bonds only cover damages in the case of theft or conversion, for example.
6. Think about setting a minimum net worth requirement. If a sizeable contract is involved, it may make sense to consider only LSPs whose financial assets meet or exceed a certain threshold.
7. Consider establishing a policy stipulating that you will only award a contract to an LSP if the deal's total value is below a certain percentage of the provider's total revenue. An LSP should not be too reliant on one or two clients.

It's important to note that the need for thorough financial due diligence doesn't end with the selection of a service provider. As we all saw during the recent recession, an organization's financial condition can change almost overnight. To avoid unpleasant surprises, make it a practice to conduct regular audits of your provider's financial stability.