We can’t discuss inventory and supply chain in 2023 without first looking at the 2022 economy. It wasn’t always sunny and that doesn’t look to be changing anytime soon. Almost every business has been affected by supply chain disruptions and rising inflation that hit 8.3 percent in August 2022. On top of that, business owners are battling rising employee costs and facing a probable recession.
So how will all of this impact your business? A few ways. Too much inventory can limit the flexibility you have in your business. Purchasing too much inventory that doesn’t move quickly will use up the available cash you need to run your business, but with supply chain concerns over the last three years, you don’t want to be in a position where you can’t get inventory either. This has been a constant battle for business owners who feel they have to “thread the needle” between these two extremes. To find a balance you will want to become comfortable with inventory and supply chain management and how they can be tools to help you with your business.
Inventory Management vs. Supply Chain Management
Supply chain management oversees the flow of products from raw goods and production sourcing through final distribution. Inventory management is an umbrella term for the procedures and processes that affect ordering, receiving, storing, tracking, and accounts for all of the goods that a business sells. It is important to know the right level of inventory to hold. You should ask yourself these questions:
- Are your inventory levels based on “Just-in-Time” or “Just-in-Case” manufacturing?
- Just-in-time was developed by Toyota in the 1970s to help meet consumer demands with minimum delays. For example, parts would be ordered and delivered within close proximity of where they would be needed in the manufacturing process. This worked well when the product was easily attainable prior to the supply chain disruptions we have seen since COVID-19 wreaked havoc over the world.
- Just-in-Case is newer terminology due to supply chain disruptions. Manufacturers are now beginning to look at:
- Can they develop the parts/products that are needed in-house?
- Do they have multiple supplier relationships as back-ups?
- And are there domestic suppliers who can provide the product?
- Are you actively reviewing your inventory movement on a consistent basis?
- Who is responsible for managing your inventory levels and have you given them the necessary tools and power in your company to be successful? Do you annually have a process to evaluate poor-selling products that you manufacture and determine if you should no longer produce these items? Slow-moving inventory is equivalent to poor cash flow. If you struggle with this problem, now is the time to examine your business and decide what items you should no longer manufacture. If you can prune the bottom 10 percent of your manufactured products, you could possibly solve part of your slow-moving inventory issue.
- How often are you evaluating your purchase costs to determine when increases in the prices of products need to occur? The days of one or two annual price adjustments are over. To stay profitable and sustainable, you have to be proactive and aggressive in pushing these price increases out to the customer. With items like lumber and steel, prices are changing daily and you have to be prepared to adjust.
Cash Flow Management
We know that inventory management affects your cash flow, so you will need to determine how much inventory is best to have on hand. Here are some other things to help manage your cash flow:
- Monitor your accounts receivable. You do not want to end up becoming the bank for your customers. During times when the economy begins to slow, customers begin to hold their cash longer which means you get paid later compared to when the sale occurred. When this happens, you are having to utilize other sources of cash for yourself like a line of credit to cover your cash demands from your business.
- Have a plan for paying your accounts payable. Do your ratios for A/R Days (how quickly you receive payment) match up with A/P Days (how quickly you pay your bills)? Try to match up your outgoing payments with your customers’ incoming payments. This will help with having to utilize as much of your line of credit and other financing avenues, which comes with interest.
- Control when and how often you make distributions out of your company for owners. Distribution should be spread out or timed for when cash flow is the strongest.
- Manage your relationship with your bank. Periodically use your line of credit to show you still need it. Have the proper amount of leveraging to help with cash flow. Continue to talk to your bank representative and let them know how business is going. Don’t be afraid to ask them for help when you need an increase in financing.
- Evaluate your staffing needs. Retaining all of your employees is not always possible when things get tight. While it’s not an ideal situation, you should know where you need to let go if and when that time comes. A best practice is to rank your team long before you have to make a decision of letting someone go. By doing this before, you are taking the personal element out of the decision which can make your decision more difficult.
Improving Cash Flow
It’s not enough to know what your pain points are. You will need to know how to track your business cash flow.
- Know your Key Performance Indicators (KPIs) and which ones you will be monitoring. For example, Current Ratio, Inventory Days Ratio, Accounts Receivable Days Ratio, Accounts Payable Days Ratio, Capacity Utilization Ratio, Scrap Percentage Ratio, Customer Return Rate, and Lead-Time Ratio are some great ones to monitor for Manufacturers.
- Prepare a budget and review all expenses. Continually update throughout the year. It is not an annual exercise!
- Reduce waste. Consider the benefits of Lean manufacturing, which focuses on minimizing waste within manufacturing systems while simultaneously maximizing productivity.
- Renegotiate with suppliers.
- Offer discounts to your customers in exchange for early payments.
- Accept multiple forms of payment. Credit, ACH and other electronic payment methods are critical for businesses. Not offering this could force consumers to look elsewhere for goods.
- Be proactive with late payers. You will need to find the right person for this job – someone who is firm and direct without threatening.
2008 vs. 2023
Looking back at history, in 2008 when the last recession hit, many companies were faced with weaker balance sheets. They were highly leveraged with debt and they were not prepared for these challenges. The difference in 2023, is the balance sheets are stronger, there is lower debt leverage, and most businesses learned from their experience in 2008, coming to the table better prepared to learn from past mistakes, quicker to pivot or adapt, and have a plan in place for a possible recession.
We have a manufacturing team ready to serve the needs of your business. Reach out to us, we are happy to help.
By Dustin Raber, CPA, CMP, Principal (Wooster office)