More Capacity Won’t Increase Revenue

Bringing Value Through CFO Insights

When a business owner is looking at growing the company, the focus rarely points at bottlenecks within operations. A search to provide new products that will bring in new customers may lead to a single train of thought that avoids considering all other options. Sometimes it is the simple solution that provides the end result – greater revenue – with little expense. Certainly, the drive to purchase new machinery as the only solution can lead you down the rabbit hole.

• Business – Metal Finishing Services
• Location – Washington State
• Sales – $3,875,000
• Ownership – single owner close to retirement

Initial Contact –

The owner was looking to retire in just 3 years. In a good planning move, he hired a consulting firm to help him increase the sale price of his business. They determined that if he could double company sales, the sale price would increase dramatically. Believing that the company’s production was limited by the size of their powder coating ovens, he insisted on buying new ovens to fill the gap. The consultants reached out to us for the analysis.

Significant Findings and Recommendations:

Business Operations

The company’s primary business was powder coating metal parts. The owner felt they were missing a significant piece of business – painting highway lighting poles – because their ovens were too small to fit the 18-foot-long poles. This single customer could propel them closer to their sales goal by bringing in $500,000 – $1,000,000 in business. The investment was $300,000 for the larger ovens and prep room.

Investigation showed that raw steel was moved into the prep room and ovens through the same narrow building that brought the painted steel to the dock. This combination building and prep room created a production bottleneck which limited the speed with which the ovens could be loaded and unloaded. And, since each piece needed to be coated twice during processing, the ovens stayed idle while the parts were prepped for the second firing cycle. As a result, the ovens sat idle 50% of the time, and production backlog extended to more than 10 days.

Recommendations

• Construct a second building, costing $50,000, next to the existing combination building. Each building will then allow for traffic in one direction. Product went to the ovens through the first building, and product came from the ovens through the second.
• Between the combination building and the ovens was a large space used for product preparation. A second prep room would allow the crew to prep steel in one building while the ovens were being used for a firing. Then, they could prep steel in the second building while the first building was being reloaded and the oven fired another batch. This brought utilization of the ovens up to nearly 100%.
• Order analysis showed that the company was losing business because of their production backlog. Orders were going to their competition, who weren’t as busy. Adding the new prep building eliminated the bottleneck, so they could bring back the excess production they were losing to competition by nearly doubling their production capacity – without buying new ovens.

Accounting and Finance Department

The company has a small accounting department where multiple responsibilities were handled by each individual. Because of the small staff, there was little segregation of responsibilities. The month-end financial package contained standard reports which provided little insight into changes in the background data. As a result, excess costs in various areas of the company were hard to pinpoint. Most production involved customer inventory, but who was responsible for product loss or insurance coverage was unclear. Cash flow was not an issue, and the company self-financed most capital expenditures.

Recommendations

• Since the company was profitable, there was a bit of laxness surrounding accounting controls and approvals. Invoices for services should be signed off by a manager before coding for payment. Invoices for product purchases needed to be triple matched to the PO, Packing Slip and physical count at the time of receipt.
• The small staff made segregation of responsibilities difficult. So, to safeguard the company’s money, the owner should review every payroll, all check disbursements, and month end bank and credit card reconciliations.
• Month-end reporting package should include profitability analysis for each production job, matched to the quote provided. This assures profitability and provided a check on the accuracy of work by the estimator.
• Sales orders should clearly state who carries responsibility for loss of customer inventory or items that don’t meet QC standards. Value of customer inventory on hand should be maintained and reported to the insurance company to assure that coverage is available in the event of the catastrophic total loss.

In small companies, the owner often thinks that he has his arms around the operation of the business, and therefore decisions are made more by gut than by pragmatic analysis. Even though rules for accounting and finance are pretty standard across businesses, the ability to identify issues relating to operations is not easy. The coordination of space, manpower and product is not a simple matter to handle. Sometimes using a spaghetti diagram, where you trace the movement of each item with a pen on a map of the shop floor can help identify where product is really moving, and where the bottlenecks are.

Even though not every company has money to spare, it is not unusual for a business owner to just arbitrarily decide that new equipment, more employees, or more space will resolve a problem. A discussion with line employees, not just their supervisors, and a hands-on view of the way the production floor works may easily identify where the problem really lies. Buying an expensive piece of equipment may seem like the right answer, but if equipment and staff are standing idle, then the solution isn’t something that is newer, larger, faster or shinier. The answer might be standing right there, staring you in the face.