Working Capital Can Improve Production Costs
Posted August 24th, 2021
Rising manufacturing costs are affecting manufacturing companies of all sizes. Many business owners solve for this through capacity reductions, plant closures, and layoffs. These are effective but drastic measures to increase working capital. There are cash flow management strategies that can increase your available working capital and improve costs of production.
First, let’s define manufacturing costs and production costs. Then we can break down how cash flow management can increase working capital. Finally, we’ll show how working capital can actually improve your manufacturing company’s production and manufacturing costs.
Expenses directly associated with the manufacturing of a product are classified as manufacturing costs. Manufacturing costs are all costs incurred in order to produce an item, but not the costs associated with operating your business. For example, direct labor is a manufacturing cost and would include the salary for your plant foreman, but would not include the salaries for your leadership or administrative personnel. These are considered indirect overhead costs.
Production cost is defined as all costs associated with the business’s output. This includes overhead costs such as rent, utilities, equipment maintenance, and factory personnel salaries not directly associated with manufacturing product.
Consider production costs like this:
Direct Material Cost + Direct Labor Cost + Factory Overhead = Production Cost
Cash flow management increases working capital
Cash flow management is recording how money comes in and goes out of your business. Cash flow management helps you identify trends and opportunities for savings, as well as forecast cash flow gaps well in advance.
It all starts by tracking your cash flow.
You can’t effectively increase your working capital until you can analyze accurate information of your cash flow. How and when does money come in, and where and when does it leave? You can track your cash flow yourself using accounting software like Quickbooks, but we encourage all of our clients to hire a CPA. A good accountant will help you find ways to save money and free up working capital. Don’t think of a CPA as an outside vendor expense; consider them part of your growth team.
Once you have a record tracking cash flow data, you can start to analyze it and forecast your cash flow. Are direct material cost increases eating away at your profit margin? A cash flow tracker will show that. Are your overhead costs out of line with your company size and revenue? A cash flow tracker makes that clear.
A good understanding of your company’s cash flow can also reveal gaps in cash flow and help you spot solutions. Can you decrease your payment wait time? Is there an option to save on materials? Those kinds of decisions impact your organizational cash flow, as well as each new customer order.
Speaking of new customer orders, every new order comes with new costs. A cash flow tracker can help you estimate what those costs will be, when you will incur them, and how long you’ll have to wait to recoup the cost of onboarding that new customer by getting paid. Financing the short-term cash flow pinch that comes with a big new order keeps your working capital free. It also allows you to pay for materials upfront, which can be used as leverage for a discounted price. There are many financing options available to manufacturers. To learn more about our PO and WIP financing, check out our Manufacturing Funding page by clicking here.
How working capital can improve manufacturing and production costs
Reducing wastes and cutting costs through good cash flow management can help increase your working capital. Now, let’s look at how that free working capital can improve production costs.
Diversify your suppliers. Invite quotes from as many suppliers as possible. Your vendor relationships should be about more than price, but price does play a role. Keep a list of suppliers you know you can count on, and estimate in their costs before you quote a new order. With the massive stress in the supply chain purchasing your materials can be a huge challenge to business right now. Access to working capital ensures you have the materials you need to execute your customers orders and keep your plant running efficiently. It can also increase your ability to get to the “front of the line” with your suppliers to get what you need.
Negotiate discounts. Access to free working capital puts you in a great position to negotiate. Most suppliers are willing to trade a discount for an early or cash payment.
Repeat these steps with transport vendors. Research transport companies that will help you unload raw material into the factory. Many local transport companies offer this option, while “big name” transport companies may not or charge extra.
Increase efficiency through managed maintenance. Working capital can be used to invest in machine health monitoring and predictive maintenance techniques. When a plant monitors itself, there are fewer shutdowns and repairs tend to be less expensive, bringing down your overall production costs.
These are just a few ways that access to working capital can improve your company’s manufacturing costs. As we move past the coronavirus pandemic shutdowns and into a renewed phase of productivity, cash flow management, lean manufacturing practices, and access to working capital will give some manufacturers a lead position in the race for growth.
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