Ways manufacturers can find better cash flow and margins

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Manufacturing

Manufacturers understand the critical importance of cash flow and margins. Yet the majority of business owners don’t do enough to protect working capital, which is the combination of accounts receivable, accounts payable, and inventory.

According to a study by Crowe Horwath LLP, 82% of US manufacturing and distribution companies believe that optimizing working capital is “extremely important” or “very important” to the success of their business. However, only 46% say they have a working capital plan in place. Another 7% of respondents say they have no intention of creating a plan to improve their operating cash flow.

“In practice, it can be difficult to manage working capital,” said Gary Cardamone, CFO Consulting Partners, director of the company’s manufacturing and distribution practice. “Business owners and their staff have longstanding relationships with customers and suppliers. It’s a lack of experience, rigor and discipline while balancing key business relationships.

For example, if a customer has payment terms of 45 days, but does not pay for 60 days, a manufacturer could potentially accept overdue payments because they have been a customer for 10 years. Why? Because that’s the way it’s been done for a long time (ie the relationship). It often works the same way with suppliers. Manufacturers have the right to negotiate payment beyond 45 days, but too often they won’t because they’ve been supplying the company for years.

According to Cardamone, “Sometimes business owners don’t want to affect those relationships. However, there is the relational side and the commercial side. Sometimes it’s about making smart business decisions to improve cash flow while working with your customer or supplier. »

Here are six more ways manufacturers can improve their operating cash flow and bottom line:

1. Use the 80/20 inventory rule.

The Pareto principle, also known as the 80/20 rule, is a time-tested observation that contains one general truth: 80% of the outputs come from 20% of the inputs.

When applied to inventory, this notion can generate more positive cash flow and higher margins. How? After looking at the numbers, business owners will learn that 80% of their revenue comes from 20% of SKUs. In other words, 80% of the remaining SKUs could tie up capital for an excessive amount of time. Let’s face it: time is money.

Jeffrey Appleman of CFO Consulting Partners, who serves as practice director for the company’s manufacturing, distribution and business services, said manufacturers need to invest their inventory dollars in data, not commentary. anecdotal stories from a limited number of customers.

“Manufacturers need to streamline their SKUs,” Appleman said. “When it comes to their inventory, management probably never focuses on financials. Business owners listen to customers, but sales don’t follow. Meanwhile, the company is overloaded with SKUs that rarely spin up. They keep large volumes of inventory to meet customer needs, but they are not grounded in reality. As a result, they tied up a lot of money.

2. Project positive cash flow.

Manufacturers must build financial models to ensure that their business will not be disrupted during drastic changes in the economy.

With supply chain issues and rapid inflation potentially causing short-term concerns about rising wages, manufacturers need to price according to the cost curve to improve their margins. If a financial analysis reveals a strong possibility that raw materials will rise 5% and wages jump 4%, manufacturers may need to implement a 6% price increase to protect or improve their margins.

“I don’t talk like a banker,” Cardamone said, “I talk like a manufacturer. Raw materials and labor are their variable direct costs. They must set their prices in the face of cost inflation to protect their profitability. Margins are directly related to cash flow. »

3. Be firm on terms.

There is a very important reason why manufacturers create terms for their customers. A process is what separates a profitable factory from the rest. Terms are a big part of the process, which can feel more like a house of cards when terms are ignored.

In other words, if customers have 45 days to pay, this should be applied. Seriously.

“Most companies don’t have enough discipline around accounts receivable,” Appleman said. “They let the customers respect the agreed conditions. It will take rigor and discipline. This will increase cash flow. If a customer has 45 days to pay and they take 90 days, that’s a big difference.

On a separate but related note, manufacturers must ensure that the terms of accounts payable match those of accounts receivable. Otherwise, it will create a serious mismatch and negative cash flow.

“That’s why companies are running out of money,” he added. “If you pay our suppliers in 45 days and your customers pay you in 90 days, that’s usually a problem.”

4. Monetize fixed costs.

You already have fixed costs, such as depreciation, taxes, maintenance, salaries and benefits in addition to a CEO, CFO and VP of operations and others general and administrative costs.

When demand begins to increase, manufacturers should be quick to generate a better return on their costs. Today you are running a shift, but why not add another for a much lower investment since a lot of infrastructure and staff are in place?

CFOs could handle the numbers and sell the idea to their CEO. They can show them what profitability might look like in 12 to 18 months. The projected numbers can even tell manufacturers when to add a third shift.

“Demonstrate how some costs are variable and move with volume and some are fixed and do not move,” Cardamone said. “With business owners, we explain what the land costs are in either of the two buckets. A CEO’s salary doesn’t go up because you produce more widgets, but the coins for widgets (variable costs) will increase with volume.

5. Protect borrowing capacity.

When manufacturers rely on an asset-based line of credit, they must ensure their lender’s terms match their customers’ terms to support operating cash flow.

Most businesses use a line of credit to meet short-term cash flow needs. If the business does not have enough cash to cover the loan, the lender may require other types of collateral, such as accounts receivable, which are more liquid than physical assets.

But there is an important point.

“If you’re borrowing against your 90-day accounts receivable and your customers don’t pay on time, that will limit your ability to borrow,” said Appleman, who served as chief financial officer for private companies. growing. “This will disqualify customers from your borrowing base and limit your ability to borrow. It’s a multi-faceted problem that a good CFO can solve quickly.

6. Leverage data to engage your CEO.

Corporate cultures, which include manufacturers, do not value the decision-making capabilities that analytics can provide, according to a recent Harvard Business Review report. Additionally, a Deloitte survey of US executives found that the majority (63%) did not believe their companies were driven by analytics, while 67% said they were not comfortable with the use of data from their resources.

Cardamone said education is how companies need to engage CEOs to ensure they are part of the process. After all, it is the CEO who has the power to bring the whole company together. Financial statements and financial records are not just for the finance department. It also includes members of the credit and operations team, to name a few.

The CFO could show the CEO the expected impact on operating cash flow if accounts receivable were reduced from 45 days to 60 days or inventory was reduced from 30 days to 15 days.

“That’s the kind of thing to show a CEO in terms of improved margins and operating cash flow,” Cardamone said. “It has to be data-driven insights that would impress CEOs. The numbers could motivate them to make changes.

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