Where Manufacturing Margins Are Slipping Without Anyone Realizing It

“Inventory is just cash sitting on a shelf.” – Kevin Golden, CPA

In this episode, Kevin Golden, CPA, talks about why margin pressure has become the new normal for manufacturers. He explains where manufacturing margins slip away, from scrap and overhead to labor that never makes it into pricing, and what leaders can do to protect profitability.

Rising labor costs, tariff swings and tighter pricing across the industry have made it harder for manufacturers to absorb cost increases the way they once could. Kevin points out that many companies know what they spend on raw materials but lose track of the indirect costs that build up around every product.

The conversation also covers which financial metrics to watch weekly instead of monthly, how inventory strategy affects cash flow and why better financial visibility helps manufacturers pressure test their business against a downturn. Kevin closes with the one move he believes every manufacturer should make right now.

Resources

James Moore Manufacturing Services

James Moore Manufacturing YouTube Channel

Watch: Where Manufacturers Are Losing Margin Without Realizing It

Transcript

[00:03] Faith: Hi everyone and welcome to the JMCO channel. Today we are here with Kevin Golden. Hi Kevin, how are you?

[00:03] Kevin Golden: I’m doing great Faith, how about you?

[00:03] Faith: Good, good, happy Monday. Today we’re talking about margin pressure being the new normal and how manufacturers are trying to stay profitable. The first question is, why does it feel like margin pressure is constant for manufacturers right now?

[00:03] Kevin Golden: Well, one, no one ever wants to say, “I made less money this year than I did in years prior.” If I make an investment, things like that, that’s understandable.

[00:37] Kevin Golden: But simply being less profitable is not usually an answer most people want to hear. So just from a pure aesthetics standpoint, everybody wants to remain on those margins to keep up profits and continue doing better.

[00:54] Kevin Golden: We want to show that, and we usually correlate that with growth. Now, there are also a lot of other costs that continue to accelerate. Look at labor. Manufacturers have a lot of labor, and that continues to tick upwards. So there’s even bigger pressure. Maybe before, if you had good margins, you could cover up costs here or there.

[01:16] Kevin Golden: As those costs continue to rise and industries continue to tighten down on pricing, those margins become more pertinent to hit. Otherwise you’re not making money, you’re losing money. So there are these other costs, namely overhead and labor, that sneak in there. You can’t really cover up these kinds of increases. They can only be maintained by hitting those margin numbers you need to hit.

[01:44] Faith: Right. So where are companies underestimating the true impact of rising costs?

[01:44] Kevin Golden: Well, one, I think some of the answer is flat out, “I don’t know what those costs are.” Most of them can tell you what their materials are and how those are doing right now, but what about all the other costs associated with manufacturing? There’s a lot more than just raw materials in your product, right? So I think where people underestimate it is some of these other costs creep up on them.

[02:12] Kevin Golden: Yes, we know labor’s a big one. But I had one manufacturer the other day where it was scrap. Their scrap had just gotten out of hand. It wasn’t that it was just there one day and it wasn’t previously. All manufacturers have scrap, right? But the amount of scrap relative to how much they’re producing just didn’t make sense. So I think there are things like that, what we’ll call profit leaks, if you will, where some of these costs just kind of sneak in and become larger than what you think because you probably just don’t think a whole lot about them.

[02:44] Kevin Golden: And scrap is one perfect example of that.

[02:44] Faith: Yeah. What are the biggest hidden margin killers you’re seeing right now?

[02:44] Kevin Golden: Probably some of the things I just talked about, some of those profit leaks. Your overhead is one.

[03:05] Kevin Golden: When a lot of people look at their inventory and their pricing models, they take into account a raw material and the person working on that assembly line. What they don’t take into account is all the people who indirectly touch it or all the costs that indirectly touch that product, right? So maybe the margins even look great, but by the time they take out their overhead, they’re not where they want to be, or maybe their cash flow isn’t where they want it to be.

[03:30] Kevin Golden: So again, some of those profit leaks can look like scrap, rework, inefficiencies. They can also look like overhead costs that have silently grown, that maybe you just haven’t paid as much attention to, either because you’re not tracking it through your inventory or it has just crept up. You’re paying so much attention to how you make your product, whether you’re doing it well and whether you’re selling the units you need to sell.

[03:59] Kevin Golden: You’re not paying attention to all these other overhead costs that are silently chipping away at it if you don’t stay on top of them. So to me, a lot of it goes back to the overhead, but also the indirect costs that impact the product you’re making.

[03:59] Faith: Have you ever had someone come to you where you look at things and uncover something big they were totally missing?

[03:59] Kevin Golden: Yeah. Again, for most people it’s just not being aware of the ripple effect of everything that touches your product.

[04:30] Kevin Golden: I had one recently, a manufacturer, and this is a pretty straightforward one. They’re just not taking labor into account. Some of that is because they have several people wearing several different hats.

[04:47] Kevin Golden: So it gets mixed up. Well, I’m not just sitting there every day making this widget. I’m making the widget part of the day, part of the day I’m selling, part of the day I’m dealing with vendors and then part of the day I’m working in the office on administrative work. They wear multiple hats because they’re a small outfit, so some of those roles get jumbled up. They’re not taking into account, “Oh my gosh, maybe 25% of my time I’m actually helping make those products.”

[05:07] Kevin Golden: I’m not covering my costs as well when I go out to price things, or I think I’m making X margin, but it’s really Y because of all these other costs that you’re not taking into account. So it’s just being very diligent about what those costs are and having a revelation about what you are or are not taking into account, whether it’s in your pricing model, your expectations for the year or your cash flow models.

[05:33] Faith: Yeah, and I feel like even more so now people are going to be wearing different hats and doing multiple jobs and tasks. So I think that’s something to actually think about. What financial metrics should manufacturers be watching weekly, not monthly?

[05:33] Kevin Golden: To me, it’s anything that really impacts your cash conversion cycle.

[05:58] Kevin Golden: Now, what is that? It runs from when we go out and spend money to buy raw materials all the way until it turns back into cash. So it goes through the whole cycle of raw materials, then WIP, finished goods, AR and cash. Now cash is back in the door and we start the cycle all over again. Anything that really impacts that, you should be paying attention to regularly, because it takes a lot of cash and a lot of capital to run a manufacturing company, from the people to the materials.

[06:27] Kevin Golden: So that really goes back to tracking how long your inventory is outstanding. How long does that inventory sit until it’s sold? Your payables outstanding, your AR outstanding, so payables and receivables, all those things that impact cash.

[06:46] Kevin Golden: Probably some of the biggest complaints people have, or at least the stressors they feel, are around cash. So anything that impacts that, you should be tracking regularly. Sometimes even daily, depending on how stringent that is or how big we’re talking about, but at least on a week-by-week basis.

[07:03] Faith: Absolutely. What should leaders be thinking about pricing in a volatile cost environment?

[07:03] Kevin Golden: Well, one, I think the knee-jerk reaction, whether it’s coming from their financial provider or themselves, is, “Okay, we’re not making the amounts we want to. Let’s increase our pricing.” That may work to an extent, but at the same time, you’re going to get pushback in your market, in your industry, in your niche of manufacturing.

[07:32] Kevin Golden: Maybe you can’t do that because of competitors. So you’ve got to really tighten up in other ways. Some of that is just being aware of all the different levers, if you will, that impact your bottom line. As a leader within the company, it’s understanding how any tweaks operationally impact you. A price increase, a cost reduction, becoming more efficient so we can make things quicker, use of technology. How does that impact where we’re trying to get financially?

[08:07] Kevin Golden: If we’re in a cash flow issue, how does that impact that? I think a lot of people just think of the pricing or just the cost. Go back to my scrap example. Just noticing that scrap is a lot higher than it should be. Well, why is that? Maybe we’re throwing away a whole lot of material that we could repurpose, reuse.

[08:27] Kevin Golden: Maybe the people working on that line just don’t understand the real cost impact of what they’re doing, so they may not realize they’re wasting as much as they are. Asking a lot of those types of questions could help you be more profitable, and maybe you didn’t increase your pricing at all.

[08:50] Kevin Golden: But then again, sometimes you need to take pricing into account, especially with the tariffs and the roller coaster ride of tariffs going up and down. Understand, when those costs come into play, what is our volatility? How much could we potentially pass on to clients before we lose out? Look at a worst-case and best-case scenario.

[09:10] Kevin Golden: So be aware of where those lanes and guides are. Maybe I could push prices up to a point, but you can’t just pass on 100% because then you’d lose out in the market.

[09:10] Faith: Yeah, and the next question ties in with that. Where does inventory strategy play in protecting cash flow and margins?

[09:10] Kevin Golden: Inventory is just cash sitting on a shelf. If you want to put it very simplistically, that’s what it is. So the longer it sits there, going back to that cash conversion cycle, the longer it takes before you can turn it back into cash you can do something else with, whether it’s buying inventory, making investments or whatever it may be.

[09:40] Kevin Golden: So I think you stay away from the extremes, like way too much inventory because we’re nervous or because we got a great discount on it.

[09:56] Kevin Golden: Okay, great, but did we actually use that discount to its fullest capacity, or did we buy so much that now we have way too much? Now we have inventory that’s obsolete that we have to get rid of and can no longer use. Well, you just ate into your discount there.

[10:12] Kevin Golden: Good intentions, bad result. So inventory management is probably something you should be looking at on a week-by-week, even day-by-day basis. But you’ve got to be really in tune with your supply chain and the relationships on that supply chain to know how quickly you need to get inventory in, as well as the demand.

[10:34] Kevin Golden: So stuff coming in as well as stuff going out. What does that really look like, and how do you monitor it properly? And when it doesn’t go the way you want, whether we had to throw away inventory or we had to delay a delivery by two weeks, why did that happen? Then constantly doing what I’ll call a postmortem, if you will. During this time period, here’s what went well, here’s what didn’t go well, why or why not and then making those tweaks.

[11:03] Faith: Absolutely. I feel like you’re the expert on this next question. How can better financial visibility actually become a competitive advantage?

[11:03] Kevin Golden: I think this ties back to what I said earlier about knowing what your boundaries are.

[11:23] Kevin Golden: Where I was getting at there is, God forbid we have another 2008 or COVID, but who knows what’s going to happen. Having better financial visibility will help you better protect yourself against the what-if. What if we grow out of capacity and I have no more room to make product? What if our product becomes so popular and our orders are so demanding that I grow to this amount?

[11:50] Kevin Golden: Well, what happens then? If I make twice as much as I’m making now, will I make twice as much money? Having finely tuned financials will help you understand what that looks like. Even better, in a market that takes a downturn like 2008 or COVID, where everything was just kind of haywire, it helps you pressure test.

[12:11] Kevin Golden: How long can we go until we’re really in trouble? What if our orders all of a sudden stopped, or not stopped but were cut by a third? What would that look like? What would that really mean? Do we have to lay off a third of our people? Hopefully not, but how can we prepare against that? You can pressure test yourself when you have really good financials that tie into what you’re doing.

[12:37] Kevin Golden: When you don’t, it’s just a shot in the dark. You may be working off good data and making good decisions, or terrible data and making terrible decisions. But good financials help you plan for the what-if. What if things go well? What does that look like? But also, what if things go badly? What if the economy, things I can’t control, go poorly? What if these tariffs come back at a much higher amount in the future? What does that mean to me? What changes do I have to make in my organization? How do I pivot? Good financials will be part of that solution.

[13:02] Faith: And I think that ties into the next question. What separates manufacturers who are maintaining profitability from those that are struggling?

[13:02] Kevin Golden: I think one of them is having leadership that is invested in running the company. What I mean by that, you hear the saying, “Don’t just work in the company, work on the company.” There’s a lot more to it than just how to make it.

[13:29] Kevin Golden: Sure, when you’re a brand new startup with five employees, that’s probably okay. It’s kind of one and the same. But as you’ve grown, especially if you’re a family company that’s been around for 30, 40 or 50 years, there’s a lot more to it than just “Can I make my product really, really well?” Can I manage other people to do the same? Can I rely on my vendors to provide the quality materials I need? Are they keeping up to the same standards? There are a lot of personnel issues and people issues.

[13:59] Kevin Golden: There’s a lot more that goes into it than just having the knowledge to make the product. That may be where it started, but it’s not where you’re at now. So I think those that, one, spend the time to really work on their business and run their business, in addition to knowing how to manufacture their product.

[14:17] Kevin Golden: And number two, being honest about what you don’t know. I’m not an expert. I’m in accounting and finance, and I don’t know everything there is in accounting and finance. There’s just too much in there. So I surround myself with people who have strengths where I have weaknesses and vice versa, and we help one another out.

[14:35] Kevin Golden: Being in tune with that and not being afraid to make that investment can help you take that next step to meet your vision and your goals, whether that’s growing at a certain percentage or whatever that may mean for you. I think people who are in tune with that and can admit to it, rather than trying to do it all themselves, are going to find themselves more successful than not most of the time.

[14:59] Faith: Yeah, and I know you mentioned multiple things that people can do to be proactive. I think it’s hard to say just one, but the last question of today is, what’s one move manufacturers should be making right now to protect margins?

[15:18] Faith: You could probably do five or 20. I don’t know, but in your mind, what is it?

[15:18] Kevin Golden: Be in tune with your costs. I know that sounds really simple, but one question I’ll ask a manufacturer is, “Okay, you make this widget. What’s your profit margin on that widget?” Then when I look at their financials and at what they thought they were making, they’re completely different.

[15:38] Kevin Golden: Now, I don’t know which one’s right. Maybe their gut is right and that’s what they’re making decisions on. Then again, maybe the financials are right and they think they’re making a lot more than that, and they’re sitting there scratching their head wondering, “Why is cash not where it needs to be? Why do I feel like I’m always struggling?” So I think one is just being in tune with your costs. That means not only being aware of all the costs that impact you and how they impact what you make, but then making sure your financials reflect that, right?

[16:04] Kevin Golden: So when you actually look at that data, it’s real data you’re looking at, not made-up numbers because you have incorrect assumptions in there. Why do I say that? Because as soon as you’re in tune with that, you know when there’s a problem.

[16:21] Kevin Golden: Now you can see, “Oh yeah, profit margin slipped by 5%. Why?” The answer to that could be a lot of different things, but simply asking that question and looking at it constantly will help you unravel it. “Oh, here’s maybe where we’re leaking. I didn’t realize this cost has gone up that much now that we’re producing at X volume.

[16:42] Kevin Golden: Okay, we need to adjust for that moving forward. Otherwise that’s going to continue to be a profit leak.” So there’s no one answer to that, but if I had to simplify it: Be in tune with what’s normal and where you want to be and what those costs really are, so you’ll know when they deviate, whether it’s for the good or for the bad.

[17:00] Faith: Yeah, and I think people need to remember that if you throw something into ChatGPT, it usually tells you what you want to hear.

[17:00] Kevin Golden: That’s true.

[17:00] Faith: That’s why going to an expert and having sound advisors is crucial to everyone’s success.

[17:00] Kevin Golden: Just like anything else, it’s a great tool, and there are going to be a lot more cool technology and AI tools to come, but it’s a tool nonetheless. It’s not you, the business owner.

[17:28] Faith: Absolutely not. Well, it was great talking to you today Kevin. I can’t wait to have another episode with you.

[17:28] Kevin Golden: All right, thanks Faith.

[17:28] Faith: Thanks.

 

Watch the Full Episode

Kevin’s advice comes back to one idea: you can’t protect margins you can’t see. Watch the full episode to hear his full take on profit leaks, cash flow and pricing, and subscribe to the James Moore manufacturing YouTube channel for more conversations with our manufacturing team.

 

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