Being a numbers-driven manufacturing CFO is a good thing – in fact, it’s essential. But as a CFO, you probably know finance and operations more than you know the ins-and-outs of manufacturing, which can lead you to measuring the wrong key performance metrics.
Here are 5 costly manufacturing industry mistakes to avoid:
Mistake #1: Using inventory costs as primary driver for performance of a manufacturing facility.
CFOs often want to drive down inventory costs to free up cash flow. On the surface, that strategy makes sense. However, what happens in the real world is that employees meet the mandate, but miss getting the inventory mix right. Employees may not be aware of all the bill of material needs and supplier lead times. Your company risks losing more money than you save when you can’t meet the production schedule because you don’t have the right parts in stock. High expediting costs for parts delivery and then customer shipments are symptoms of having inventory not right-sized to your actual use. Instead of measuring on inventory cost, use tools to forecast the right inventory mix and safety stock you need to keep your plant running smoothly.
Mistake #2: Using labor efficiencies as a performance measurement.
Labor is cheap! For U. S. manufacturers, labor costs account for less than 10% of the overall product cost. Many large corporations use labor costs as a KPI, but for manufacturers, focusing on labor costs does more harm than good. When manufacturing CFOs try to decrease labor costs, manufacturing is then forced to make product runs in larger batches. Large batch sizes turn raw inventory into finished good inventory too early, consumes warehouse space, and drives up inventory holding costs. Additionally, the company’s agility is reduced by consuming the raw materials early that could have been used to create multiple other products.
For a true business transformation of your manufacturing operations, you should expect a decrease in labor efficiency more than offset gains in profitability. More time is consumed switching between smaller, more profitable jobs.
Mistake #3: Making decisions using absorption costs.
While absorption costing has its place in high level reporting, it provides very little information that can be used to drive management decision-making. In fact, it can be very misleading to report inventory as an asset. For example, if sales hits a slowdown and manufacturing doesn’t respond quickly to reduce production, the inevitable increase in finished goods increases the assets of the company. In reality, this should be seen as a warning sign and not an improvement in financial position. Direct costing or variable costing will provide much deeper insights as to the true cost of your manufactured product.
Mistake #4: Choosing suppliers by lowest cost per unit.
Low cost is certainly a high priority but selecting suppliers based on only lowest cost per unit is an extremely poor way to determine where or how you should manufacture product. The risk of comparing low unit cost to standard cost is that while you may “beat your estimate,” there are a number of other variables that must be considered when determining sourcing – like reliability of supplier, quality control, lead times, supplier capacity, and flexibility to meet exceptional situations.
Mistake #5: Outsourcing the easy stuff.
Anyone can do the easy stuff! That’s true – and that’s why you don’t save much by outsourcing the easy work. If you instead focus on finding a reliable supplier who can do the work that’s highly detailed, takes a long time or most people don’t like to do, you can create strategic differentiation. Plus, you’ll keep your in-house employees happier.
Running a manufacturing business is not easy. MCA Connect can help align your people, technology, processes and performance measurements so that you have the very best chance of success.
Contact us if you’d like to talk more about aligning your people, technology, processes and performance measurements so that you have the very best chance of success.
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Author: Doug Bulla