Imagine speaking with a team of highly functional production personnel who have improved their manufacturing processes, reduced waste and increased capacity. You ask them about the financial impact of their improvements… only to receive blank stares back. Or perhaps you’re discussing how purchasing high quantities of inventory impacts cash flows, but confused looks are their only reply.
For a manufacturing entity—or any entity for that matter—financial literacy is critical in connecting operations to their financial impacts. Otherwise decisions will be made that could be detrimental to the business, no matter how well intentioned.
Yet when speaking with chief executives of manufacturing entities, we’ve found that one of their biggest frustrations is the lack of financial literacy among non-finance personnel. Many times these team members lack a basic understanding of financial statements, particularly in areas like working capital, inventory costing, gross margins and EBITDA.
This is never more apparent than in monthly meetings to discuss operating results. While non-finance personnel can discuss operational statistics at expert level, it’s difficult for them to see what that means financially. Furthermore, finance personnel often struggle to explain working capital needs or why overhead rates are fluctuating (let alone the impacts of Lean or other process improvement methods on the financial statements).
In a classic example of the absence of financial literacy, a manufacturing company we worked with was always at a break-even point. Although it had a high volume product line and a low volume product line, key personnel didn’t know their product costs. It turns out the high volume product line was extremely low margin, while the lower volume product line had high enough margins and just enough sales to help keep them break-even.
This lack of understanding was clearly costing the company profitability. With this newly found information, the company improved its margins by making key decisions in the manufacturing process as well as supplier pricing.
How can you avoid this situation at your company? Start with some basic training on financial statements and other related matters. While there’s no need for your non-financial personnel to become accounting professionals, you can teach them some key topics to increase their financial literacy:
- The balance sheet and its purpose
- Working capital and the needs of a growing company
- The relationship between accounts receivable turnover and inventory purchases
- Inventory costing and its various components (raw materials, direct labor and overhead)
- Property and equipment and depreciation
- The income statement (also known as the profit and loss statement, or P&L) and its various components:
- Cost of goods sold
- Gross margin
- Selling, general and administrative costs
- Other costs
- Net income
The challenge is putting an internal program together that covers all of this information in a meaningful way (not to mention the time commitment involved).
One solution is to work with manufacturing CPAs who have the specified knowledge of your industry and its financial operations. Local universities or colleges, as well as your local manufacturing association, may also have such programs. In fact, the Volusia Manufacturers Association will be putting on such a program in beginning in June; you can click here for more information.
A high functioning team means a well-rounded understanding of business that includes not only the operational side, but also the ability to connect operations to financial statements. Armed with better financial literacy, your entire team can work together to increase profitability.
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