By Kurt Dyck, CFO & Business Advisor
The average small business manufacturing company produces anywhere from dozens to hundreds of thousands of products a day. It’s an environment where even the slightest improvement in operations can result in substantial savings of both time and money.
For business leaders seeking solutions on how to increase revenue or become more successful, the manufacturing blueprint is an excellent model to replicate. Manufacturing focuses on four core principles: inventory (both raw and finished), forecasting, cost accounting, and production. It seeks to eliminate bottlenecks (what the business world refers to as challenges), always keeping the end goals in sight: more efficient, manufacturing, inventory management, accounting, and sales.
A great book on this subject is The Goal by Eliyahu M. Holdratt. (https://en.m.wikipedia.org/wiki/The_Goal_(novel)). This is no ordinary business book- it reads more like a novel and is often cited for its ability to help improve management, efficiency, communication, and demonstrate constraint theory principles.
Increasingly, Lucrum has been called upon to assist more manufacturing businesses. But what we have found is, for all the focus on production efficiency, manufacturing businesses make the same financial mistakes we’ve seen with other non-manufacturing clients. Here are our top financial mistakes from manufacturing but make no mistake, there are valuable lessons here for all businesses:
- Not Managing the Cash Conversion Cycle – The nature of manufacturing typically requires that a raw material is purchased, is altered and/or assembled into a finished part, the finished part sits on a shelf, before being sold to a customer, and then receivable is collected from the customer. The cash conversion cycle is the time from paying for the raw material until collecting from the customer and if not managed well, can easily become a drain on cash flow. In addition, the largest cost for most manufacturing companies is typically raw materials and the most complex process is generally the procurement of the raw materials. If production forecasts, , and supplier lead times are not managed properly, a manufacturer can suffer inflated inventory values and lost profitability when the inventory is finally sold. But it also increases the cash conversion cycle since there is more cash invested in the inventory and won’t be recouped any quicker than normal. Metrics to help manage these areas are Inventory Turns (Inventory), Days Payable Outstanding (Accounts Payable), and Days Sales Outstanding (Accounts Receivable).
- Using the Wrong Cost Accounting System – Key to understanding the success of a manufacturing company is having accurate profit margins for products, distribution channels, locations, or whatever business segment is analyzed. Of course, manufacturing businesses vary in complexity, so it is imperative management has a cost accounting system that supports the level of data entry the business can handle, as well as produces the data and reports necessary to understand and manage the business. Ideally, a good cost accounting system will allow for the accurate allocation of materials, labor and overhead costs, which will enable management to successfully understand, analyze and improve profitability. With an insufficient cost accounting system management will not have the necessary tools to impact profitability.
- Inaccurate Forecasting – Much of the success of manufacturing companies is dependent on the efficient use of resources such as raw materials and employee labor. Some raw materials and skilled labor can be difficult to procure, making accurate forecasts essential. In addition, large spikes in volume can lead to resource shortages, or large drops in customer orders can result in excess materials or capacity. Lucrum recommends all of our clients go through an annual budget process and that the budget be updated periodically as a live forecast as these spikes in volume or changes in customer orders occur; this is even more important for manufacturers than most businesses.
- Not Using A Dashboard – Manufacturers rely on many repetitive processes to procure, produce, assemble, sell, and transport a product. Among these many processes will be several key steps that are integral to success. The important thing is to continually identify the key processes, measure them, and make sure the appropriate people are aware of them and acting appropriately. A dashboard can take many forms, from a “Glass Wall” shown in the manufacturing area, a television screen in the break room, a daily email sent to the management team, or a formal page in the monthly management report. This dashboard can list measurements like sales comparisons, on-time delivery performance, customer satisfaction, and lost time incidents.
- Ignoring Employee Input – Manufacturers rely on “front-line” employees in critical processes. These employees see first-hand what is working and what isn’t, speak with customers, process returned products, fix broken machines, etc. They are often able to identify trends before management, and also have great ideas about how to improve products and processes. Too often we see business owners or management insulating themselves and not listening to the “boots on the ground”. One Lucrum client goes as far as publicly rewarding employees for specific customer feedback, ideas of the month, or other time/cost saving fixes. The incentive ranges from an extra day off, cash compensation, or public recognition at the next team meeting.
All businesses can learn from common financial mistakes in the manufacturing industry. If your business needs assistance repairing any of the processes listed above, please contact Lucrum Consulting. Our team can help you identify the best methods available to help you better track your business’ financials so you can see quick results in the form of increased profitability and efficiencies.