Key Manufacturing Finance Concepts and How They Impact Success
SVP, Director of Treasury Services
Manufacturing is a cash-intensive sector. Businesses need to purchase inventory and expensive equipment, and they often have a lot of capital tied up in these assets.
Long sales-production cycles can intensify this aspect of manufacturing operations. It might be weeks or months between when your company incurs production costs and when you finally get paid for a sale.
Understanding and monitoring the key manufacturing finance concepts can help you better align cash outflow for capital expenditures with production, increasing efficiency and improving your bottom line.
Finance vs. financing
Finance is a big-picture work process involving management of assets, liabilities and equity. In well-run enterprises, it's also an integral component of operations.
Financing is a component of a finance strategy. It refers to the tools used to acquire and manage your company's liabilities and equity to acquire assets. These assets help generate revenue and profit. They may also provide liquidity to support operations.
The goal of finance is to measure and monitor the financial health of your organization. The finance department monitors critical metrics and trends, providing this data to senior leadership. These insights help business leaders make strategic decisions that streamline operations and increase efficiency.
Gross and operating margins
Manufacturing has high overhead, as well as a high cost of goods sold—the cost of all the inputs needed to produce the product, such as labor, materials and shipping. That's why two of the key metrics that finance departments in the industry focus on are gross margin and operating margin.
Gross margin is a percentage determined by dividing gross profit by sales. It tells you how efficient your business is at converting products into revenue. Track gross margin overall, as well as by category and product, for truly useful information.
Operating margin is the percentage of sales you retain after subtracting all your operating costs. It's based on operating profit, which is your gross profit minus your selling, general and administrative expenses, or SG&A. You can really tap into this data by allocating your SG&A accurately across your product lines.
Your gross margin will tell you what products are more profitable. Meanwhile, operating margins show you how well you're using your resources. These insights can help you adjust your pricing, reallocate resources or retire products.
Other key metrics
The amount of time it takes from to complete one production item is called cycle time. You can break down this number into smaller components, looking at metrics like machining time, assembly time and movement time between processes.
Inventory includes raw materials such as steel and work-in-process, which is partially finished goods that you purchased or produced. Inventory turnover, measured as a ratio, tells you how frequently your inventory refreshes in a given period. If your inventory turnover is low, you may need to rev up sales, change your product mix or find new distributors.
Cash on hand
Because cash is so critical, knowing your cash on hand number is crucial. Cash on hand is the amount of actual cash you have in your bank or other accounts or on premises. This number, shown on the balance sheet, fluctuates daily. Your ability to actually forecast this number 12 weeks out will help you in managing your cash.
Manufacturing business loans
Depending on your operational needs, it may be appropriate to seek financing in the form of business loans. Two types of loans in particular can provide crucial funding—credit lines and equipment term loans.
A credit line can help cover the gaps between when cash flows in from invoices paid and when it flows out to pay payroll and bills. Credit lines fluctuate up and down on a monthly basis, and it's a best practice to pay them off periodically—at least a few times a year.
An equipment term loan is for purchasing equipment. These can be helpful in situations where purchasing equipment with operational funds would tie up too much money that you need to pay vendors or employees. By paying back a loan over time, you can more closely match the outgoing cash you use to pay for the equipment with the incoming revenue that the equipment generates by helping you produce or deliver products.
For help determining how to best utilize debt, contact your business banker. They have significant experience assisting with financial decisions tailored to a company's unique situation. They can help you strengthen your business financially as well, support tighter integration between finance and operations.
Financial insights for your business
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.