Manufacturing Financial Statements: A Guide for Business Owners

Financial statements are key to the success of every business, providing an objective summary of a company’s financial performance over a period of time. In the manufacturing industry, financial statements provide a critical window into a company’s operational efficiency and profitability. This gives management teams the insights they need to make informed decisions and build company value.

However, many manufacturers fail to leverage their financial reports effectively. Producing financial statements isn’t just a check-the-box type of exercise to keep your business GAAP compliant and satisfy your financing partners. They’re a diagnostic tool — one that can help you catch evolving issues, address inefficiencies in your production process and build a better business.

The key to success is not just reviewing financials but understanding the story they tell about your inventory management, pricing strategies, overhead costs and cash flow. In this guide, we’ll start by introducing the key manufacturing financial statements. But we’ll spend far more time exploring the ways you can leverage them to improve the operations of your business.

Armed with these insights, you’ll be in a much stronger position to manage your business’s financial performance –– a task the manufacturing team at James Moore is well-equipped to help you with.

Types of Manufacturing Financial Statements

Manufacturers rely on three primary financial statements to track performance and make informed decisions: the income statement, balance sheet and cash flow statement.

Each statement provides distinct insights into the financial health of a business and serves a unique role in financial management. Businesses should produce them on a monthly basis as part of the month-end close process.

The income statement, also known as the profit and loss statement (P&L), shows the company’s revenues, expenses and profitability over a specific period. It details revenue from sales, the cost of goods sold (COGS), gross profit, operating expenses and net profit. Assessing the income statement every month allows business owners to track revenue, monitor profitability and understand their cost structure.

The balance sheet provides a snapshot of the company’s financial position at a given moment. It lists the business’s assets, liabilities and equity, offering a clear picture of what the company owns versus what it owes. On the assets side, key components to track include the business’s current assets (including cash, inventory and accounts receivable) and fixed assets like machinery and real estate. For liabilities, management should pay close attention to the business’s current liabilities. These are financial obligations due within a year, such as accounts payable, lines of credit and accrued expenses. Long-term liabilities, such as bank loans and leases, should also be considered.

The cash flow statement tracks the movement of cash into and out of the business, dividing inflows and outflows into operating, investing and financing activities. Unlike the income statement, which includes non-cash expenses such as depreciation, the cash flow statement highlights actual liquidity––a crucial factor in the sustainability of any business. Manufacturers should use this statement to understand their cash conversion cycle, ensure they have liquidity to cover expenses and take proactive measures to manage and improve cash flow.

Some manufacturers will also produce a cost of goods manufactured statement (or COGS), although this is becoming less common. This statement calculates the production costs incurred by a manufacturing business during a specific period, including materials, labor and manufacturing overhead. This provides management with a more granular understanding of their COGS.

Read More: Knowledge is Power: Financial Literacy for Non-Finance Personnel

Best Practices for Interpreting Manufacturing Financial Statements

Understanding the role of each of the financial statements described above is one thing, but it’s another entirely to fully grasp how to use them to drive your manufacturing business forward. By following the best practices outlined below, management teams can elevate the utility of their financial statements and act based on what the numbers are telling them about their business.

Calibrate Expectations with Reality

Manufacturers must track whether their financial performance aligns with expectations. This tends to be most evident in gross margins. The starting point is comparing the actual gross margin shown in the financial statements with the gross margin management expects to see based on the quotes issued to customers. If there are discrepancies, it’s important to dig into the reason. We typically look at this across three key areas:

Material Costs

If material costs have increased, it’s first important to understand why. Perhaps cost increases are attributable to operational inefficiencies, or maybe the cost of raw materials has increased. If it’s the former, focus on making operational improvements. But if it’s the latter, these adjustments must be reflected in pricing strategies. This doesn’t just refer to the costs of raw input materials; manufacturers must also account for wastage in their processes, inventory carrying costs and more. Regular audits of material consumption can help identify areas where waste is occurring.

Labor Costs

Similarly, labor costs must be tracked accurately. Issues such as excess downtime or underestimation of labor requirements can lead to unexpected increases in production costs, while inefficient use of machinery can drive up operational costs. Monitoring productivity and scheduling preventative maintenance can reduce downtime and lower costs over time.

Don’t forget to factor in indirect labor costs. If these costs are not properly accounted for, pricing may be set too low, resulting in losses on what should have been profitable work.

Overhead Allocation

Facility expenses, machine depreciation and indirect costs should be distributed across production jobs appropriately. Misallocating these costs, or failing to allocate them entirely, can result in misleading profitability numbers that give business owners a false sense of security. That can lead you to include overhead rates that are too low in your proposals. So it’s important you constantly assess your company’s overhead rates and ensure they’re reflected in the quotes issued to potential customers.

When expected margins differ from actual results, it often points to deeper inefficiencies. These can include excessive material waste, underpriced jobs or production bottlenecks. Identifying and correcting these issues can lead to significant improvements in profitability.

At James Moore, we like to look at each of these costs as a percentage of revenue on a monthly P&L statement and analyze these numbers in the context of a trailing twelve-month basis. This approach enables management to identify trends and take more proactive action to protect their margins.

Inventory Valuation and Financial Reporting

Inventory is often one of the most significant assets on a manufacturer’s balance sheet. Mismanagement of inventory, through either costing or quantity issues, distorts financial statements and misrepresents the company’s financial position.

Manufacturers must establish a clear system for valuing inventory. Businesses must understand which method best represents their cost structure and use it consistently. Regular inventory reconciliations are also essential. Variances could indicate theft, waste or inefficiencies in tracking materials, all of which affect profitability. Don’t forget to account for the carrying costs of retaining excess inventory. Such inventory takes up space in your warehouse, consumes employees’ time and may even be financed by a line of credit.

Work in progress (WIP) accounting presents another challenge. Many manufacturers struggle to accurately capture the value of WIP inventory, which can lead to misstatements in financial reports. If WIP is understated, costs of goods sold may be inflated, making profitability appear lower than it truly is. On the other hand, overstating WIP can create an illusion of profitability when, in reality, your funds are tied up in unfinished products. Ensuring inventory figures are precise allows manufacturers to make informed business decisions.

Read More: Best Practices for Effective Inventory & Supply Chain Management

Leveraging Financial Statements for Better Decision-Making

Financial statements shouldn’t be treated as historical documents that are only reviewed periodically. Instead, they should be used as active management tools that guide daily operations and long-term planning.

Monitoring trends in your business’s financial performance is essential for identifying patterns and addressing fluctuations in profitability before they become major problems. If margins are shrinking over time, manufacturers must investigate the root cause and take corrective action. Unlocking the ability to adjust pricing strategies based on up-to-date financial data is another key benefit of routine financial analysis.

Investing in real-time financial reporting tools can help manufacturers track performance on a daily or weekly basis instead of waiting for monthly financial reports. Some enterprise resource planning (ERP) and material requirements planning (MRP) systems provide dashboards that give immediate insight into cash flow, inventory levels and profitability. But in many instances, little data is provided and you may need to build these yourself. Key metrics to include here might include:

• Gross margins
• Material, labor and overhead costs as a percentage of revenue
• Working capital ratios
• Accounts receivable
• Days of inventory
• Leverage ratios

Regularly reviewing these metrics, as well as the more comprehensive financial statements, helps leaders proactively identify financial performance issues in their business. It’s important to do this every month; reviewing financial performance on a quarterly basis leaves far too much time for issues to evolve into significant business challenges.

Strengthen Your Financial Statements with James Moore

Manufacturing financial statements are much more than compliance documents. They’re essential tools for improving efficiency, profitability and financial stability. When used correctly, the comprehensive financial data they provide uncovers valuable insights into the cost structure, cash flow management and operational performance of a manufacturing business.

Manufacturers who actively monitor and manage their financials can uncover inefficiencies, improve margins and strengthen their overall business strategy. Regular financial reviews and the integration of financial insights into operational planning are necessary to stay competitive and build for long-term success. Plus, if you want to sell your business, it’s vital that your historic financial statements are GAAP compliant and ready for the scrutiny of an acquisition process.

At James Moore, our manufacturing team specializes in providing strategic financial guidance for manufacturers. We provide a range of solutions, from fractional CFO services and HR consulting solutions to audits, tax planning and more. With decades of combined experience advising mid-sized manufacturing companies across the country, the team at James Moore is well equipped to help business owners strengthen their financial foundation and build a more successful future.

Contact us today to learn more about how we can help your business.

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