Quality Control Can Impact Cash Flow

Author: Larry Chester, President

It’s critical that manufacturers deliver what their customers need and want. But sometimes manufacturers are so concerned about sales, that they overlook the specifications on the POs that they receive, acting like they know the client’s needs better than the client does. This is not a place for ego to get involved. When there is a dispute between the customer and the custom manufacturer of a product, it is the customer who wins—and it can be costly.

Bringing Value through CFO Insights

Quality control should set standards for both sides of the manufacturing plant, inbound and outbound. If the raw materials that are received don’t meet the job requirements, it’s possible the manufacturing process might not be successful—either for you or the customer. And, if the quality of the items that are produced don’t meet the specifications that the customer has set, then all of the time and material that’s gone into that production run are at risk. This might be a momentary hiccup, or a long-term disaster for the company, but why take a chance?

• Business – Manufacturer of cold-formed screws and bolts
• Location – West suburban Chicago
• Sales – $7,500,000
• Ownership – Single owner with a major investor

Initial contact –

The owner of the company had been introduced by their corporate attorney. For more than three months, the owner insisted that he could handle their situation. In the end, he called and asked us to start work “tomorrow.” When we arrived, he ushered us into his office and said, “I’m glad that I finally have a CFO to help me out. Your first job is to figure out how we’re going to cover payroll on Friday.”

Significant Findings and Recommendations:

Cash Flow Shortage

The company started with seed money from the owner’s father. The owner was a skilled engineer with little business experience. The company had been losing money for years and had burned through the owner’s nest egg.

Recommendations

• Create a cash flow forecast to determine the ongoing cash shortage. This was needed to understand how much cash the company was burning through monthly, in addition to determining how much more cash they’re going to need in the coming weeks/months.
• Develop an ongoing evaluation of each manufacturing run’s profitability. In that evaluation, be sure to include all the elements that might have been coded to operating or overhead expense. Use these evaluations to reset the estimating process to assure accuracy.
• Identify any ongoing variances. Determine if those are unique to an individual run or indicative of a mispriced production process.
• Look for ready sources of cash to take care of the current shortage. Contact existing customers to ask for early payment of invoices. Reach out to customers placing new orders, asking for deposits on the orders to cover raw materials. Stretch out payables one to two more weeks to get more cash availability to take care of immediate obligations.

Quality Control

The owner, who was also the head of engineering, would quote and then accept orders that were beyond the capabilities of their manufacturing equipment. The result was returned product, wasted production time and materials, and significantly increased freight costs.

Recommendations

• Develop an initial review of Requests for Proposals, verifying that the requested specs match the equipment capabilities on the production floor.
• During the quoting process, assure that the quality requirements and part specifications requested by the customer are agreed to by the production manager.
• Submit pre-production samples to the customer for approval prior to full production runs—especially when there are any questions about the specs or where the customer has rejected product previously.

Rush Charges for Outsourced Services

Since cash was in short supply, needed raw materials were not ordered until production was set to begin. The result was that there was no time available for normal manufacturing delays. Many orders required further processing by other suppliers, who at times of heavy production, were unable to process orders on a timely basis without resorting to overtime, rush, or break-in charges. Those charges added up to a significant amount month after month.

Recommendations

• Order raw materials far enough in advance to ensure enough time to properly produce product for customers, including the time needed by outside processors.
• Approach outside vendors to pre-schedule time in their plants to match upcoming production demands, avoiding delays and scheduling problems.
• Negotiate a more favorable schedule for processing based on production volume.
• Locate additional processors with more flexible schedules, or greater production capability.

Quality control can be a big problem for any company. The biggest problems occur when production is rushed or management overrides the decisions of the QC department in order to rack up more sales. In turn, when product is shipped that doesn’t meet the needs of the client, it’s much like a Hail Mary pass downfield. In this case, the hope is that they will need the product badly enough that they will skip some of their own inbound QC checking and just accept the shipment. The result is disaster. The customer loses confidence in the ability of the manufacturer to meet their needs, which might be the trigger to start looking for an alternate source.

The situation also presents a financial problem—when the customer returns the product as unsatisfactory. This results in:

• Additional freight costs to return the product
• Wasted manpower and raw materials
• Rejected invoices for the shipped items
• Raw material invoices that still must be paid—without incoming cash to cover
• Cash flow shortage and income statement losses

Lack of care in manufacturing results in potential problems with quality control. The decision to ship inadequate product, scrap defective merchandise, or rework inventory attempting to meet standards creates problems with customers, generates waste and/or additional costs. Remember, proper planning prevents poor performance. Effective quality control should be a key component of your production processes.