Knowing the actual cost of production is critical to setting accurate pricing and therefore profitability for any manufacturing company. How are your costs being confirmed and posted?
Setting the proper pricing for any product is the result of understanding the market, your competition, and your cost of goods sold (COGS). The problem arises when the actual costs are different than the ones that are being “understood” by production staff, estimating, and the sales team. Getting to the real numbers are the key to profitability.
Initial Contact – The business owner had used a part-time CFO for many years, but they recently moved on to a full-time position elsewhere. Current financial staff consisted of an accounts payable clerk, an accounts receivable clerk, and an accounting manager.
Their ERP system was a shop floor package designed for the printing industry. Cost segregation and production reporting were excellent, but financial reporting was weak. The dashboard created by the former CFO had items on it that the owner didn’t understand, and he focused on a few numbers on the income statement rather than truly understanding how it all fit together.
The accounting manager cleared out the manufacturing variance account monthly by adjusting it against COGS. This created wide variations in profitability that were unexplained. The prior CFO convinced the owner that the variances were caused by a bug in their ERP package. The owner had gotten used to the variability month to month, and looked at quarterly, or 12 month rolling reports instead to determine how the company was performing.
Half the variances balanced out exactly in two or three months. Analysis of production showed that not all items produced were ready to ship upon completion, due to quality issues. Closing the production orders prematurely caused improper financial reporting of manufacturing. Therefore:
The remaining variances were the result of differences between the estimates and actual production costs. A variety of production problems were the cause.
Financial statements tell what is happening on the production floor. If the detail isn’t sufficient to identify what needs to be fixed, a deeper analysis of the financial impact of company operations will identify where the problems lie. In some cases, the fault is in carelessness on the production floor, causing wasted raw materials, or wasted time. In other cases, the cause is procedural, where production posting doesn’t accurately reflect available product and thereby impact the company’s financial results.
The astute business owner doesn’t just look at the top line and the bottom line to determine the success of the company but reviews the accompanying analysis to see if expectations are met. The key for many companies is management by exception. Set standards and guidelines for financial and operational performance. Certainly, strive to improve. But exceptions to standard results need to be scrutinized and resolved, or the exceptions become standard practice – and quality and profitability suffer.
Most business owners get financial reports monthly: Profit and Loss, Balance Sheet, Statement of Cash Flows. Some look at them
Often, I’m told by a business owner that they don’t understand why their financial statements show strong profitability for two
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