For over 50 years, shippers have outsourced the audit and payment of transportation freight bills. And it's still a popular practice today. While it might not be at the top of the list of most commonly outsourced supply chain-related functions, nearly a third of the North American respondents to the 2013 Third Party Logistics Study conducted by Capgemini and others reported that they outsourced this task.
There are significant advantages to outsourcing freight bill auditing and payment (FBAP), but because of the amount of money that flows through the process, it's important to exercise extreme care when doing so. Ten years ago, the industry suffered a blow when two large freight bill payment companies left clients with over $25 million in unpaid freight bills. Now, it's happened again, with two companies recently accused of leaving their clients liable for millions of dollars in unpaid invoices. One of these situations was at least partially a result of embezzlement.
Fortunately, these are the exception, not the rule. Most of the players in this industry are financially sound, well-managed businesses, and we don't want to throw the baby out with the bath water. Nonetheless, the general business climate—as well as common sense—dictates that prospective outsourcers conduct thorough financial due diligence in selecting a provider. Remember, if the provider doesn't pay the carriers, you as a client are liable for the charges, even if you have already advanced the funds. Also keep in mind that the FBAP industry is not regulated, making it even more critical to investigate, analyze, and verify.
While nothing can be outsourced without some risk, I believe there are 14 steps that, if taken, can minimize the financial risk to the outsourcer. They are as follows:
- Insist on inspecting audited financial statements—even if the firm is privately held. Don't settle for banking information, which may be helpful but is not always a reliable indicator of financial health. If the FBAP firm is financially healthy, responsible, and capable of handling the business, it will find a way of demonstrating its stability.
- Investigate the reputation of the auditing firm used by the provider. Things are not always what they seem.
- Make sure the financial statements and other documents are examined by qualified financial specialists. If the task is left to a supply chain manager with no background in finance, there's a risk he or she will overlook clues to financial problems.
- Check out the reputation of the senior management of the FBAP firm. Keep in mind that regardless of how good established controls may be, they can always be overridden by senior management.
- Ask for assurances that the firm's financial controls are tested at least annually by an independent auditor. While privately held firms are not required to be Sarbanes-Oxley compliant, some FBAP firms have become so voluntarily. They are then subject to various tests for operational effectiveness and reporting requirements. These annual reports will be an excellent source of information about the firm and its processes and controls.
- Be sure that your company's funds are not co-mingled with those of the provider. The typical FBAP firm's business model requires that clients advance it the funds for freight payments, usually on a weekly basis. It then holds these funds while bills are being further processed and verified and checks prepared. All funds for freight charges should be held in a separate account—preferably, at a separate bank. Or if you want to be extra cautious, you can insist that the provider maintain a separate account just for your funds.
- Understand the float. During the delay that occurs between the time the provider receives the funds from the client and the carriers cash their checks (or receive a wire transfer), the advanced funds are considered to be "floating." Often, a provider will make short-term investments with these funds before it pays the carriers. This can be particularly advantageous when the float amount is significant and interest rates are high, and there is nothing inherently wrong with this practice. However, it's important that the client be aware that this is part of the process and that it has a right to know how its funds are being used.
- Make sure the provider has a fidelity bond that would cover possible embezzlement of client funds by employees. And check to see that the coverage is adequate.
- Be sure the contractor thoroughly vets its employees. It should adhere to a strict policy of running detailed background checks on all new employees and credit checks on anyone who would have access to funds and/or cash management. Credit checks are common in banks and other institutions dealing in liquid assets. Unfortunately, a person who is deeply in debt should be considered a risk.
- Confirm that the contractor maintains a separation of duties in accounting and cash management functions. This is to ensure that a single employee (or group of employees) cannot manipulate funds or bypass controls.
- Verify carriers. Make sure the funds are being paid to carriers that actually exist.
- Finally, and most importantly, manage the relationship. Since one of the primary reasons for outsourcing is to ease the client firm's workload, too often these firms put the relationship on automatic pilot once the contract is signed. But it simply is not sound business practice to outsource an important financial activity like FBAP and then ignore it. Make it a practice to conduct periodic audits. Also, appoint a relationship manager who will be available at all times in the event the provider needs information or guidance.
If the client firm is large or the amount of freight charges involved is particularly significant, there are two other controls to consider: - Explore the possibility of establishing minimum limits on financial assets. Stated another way, be sure the FBAP firm is large enough to handle your account.
- Consider establishing a policy of awarding contracts only if the value of the contract is below a certain percentage of the provider's total revenue. A freight bill audit and payment firm should not be too reliant on one or two accounts.
Bottom line: The outsourcing of freight bill audit and payment is an important financial step for a shipper and should be treated as such. Because these arrangements are often complex and require the client to relinquish control of large amounts of money, financial due diligence must be at the top of the list when qualifying potential providers. While no outsourcing arrangement is absolutely risk free, the client should ensure that its funds are as safe as they would be under its own management and control.
