Due diligence at the EMS provider: Key operating and financial indicators

Are sales falling or is production rising too fast?

By Mark Zetter

When OEMs evaluate electronics contract manufacturers, it’s not enough that a particular contract manufacturer has a history or experience in the field of expertise, or product end-markets, the OEM is marketing its products in.

OEM executives must also be comfortable understanding the contract manufacturer’s financial position relative to his business profit objectives and, that the contract manufacturer will be around for a while to serve the needs of the OEM.

Below are some of the financial operating and overall company indicators, and a few possibly related causes, OEM executives might want to look into more closely when evaluating contract manufacturers for the purpose of engagement.

Naturally, it is easier to gain access to some of this information from publicly traded contract manufacturing companies. (Click here for more detail on metrics and liability)

Earnings statements

Inventories
High inventories might possibly indicated the following: quality of the products manufactured by the contract manufacturer has slipped; the competition is building a better-quality product for the same customer, or end-markets some of the contract manufacturers’ customers are financially strapped production costs are out of line the contract manufacturer is no longer price competitive.

One question executives should ask is, “are sales falling or is production rising too fast?” Keep in mind, companies may hold back some inventories while waiting for new product introductions (NPI).

Rising receivables

Most explanations for rising receivables are usually bad if receivables are rising faster than sales (relative percentage for each). Possibilities for this might include: customers are paying the contract manufacturer to slowly (again, due to financial troubles of their own, or business disputes) ‘channel stuffing’ or, increased shipments at quarter end to help make the quarter numbers (essentially, stealing from the following quarter) could be talking place.

 

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Extraordinary losses
Look for inconsistencies. In years one through three, for instance, the contract manufacturer reports steadily increasing operating earning profits (with its stock price rising). Then, in year four the company reports an extraordinary loss per share, but adds that operating earnings, before the loss, were healthy. It could be there has been some neglect in capital spending necessary to maintain infrastructure in a high capex industry such as contract manufacturing.

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