The Finance Advantage: From Numbers to Strategic Action

Getting Actionable Financial Data

Like most manufacturers, you get your basic monthly financial reports from your bookkeeper, accountant, or an outsourced accounting provider.

Most bookkeepers and accountants provide you with generic financial statements. These are built specifically for external decision makers such as creditors and investors. They are not built for internal decision makers, such as yourself and managers within the business. Generic financial detail may provide a record of where your business has been, but they are not very helpful for determining what needs to change in order to increase future financial performance.

The Hidden Costs of Not Knowing

The problem is two fold.

First, generic financial statements leave you looking into the rearview mirror. It doesn't allow you to navigate the road ahead.

Second, the financial reports you likely receive do not provide actionable detail into how to improve the business.

Without a dedicated finance function, you're missing out on key insights that can be used to transform and improve your business. Here are only a few examples of many details that may not be apparent using generic financial data:

• Underpricing your products because looking at consolidated financial statements fails to show the true cost of production for specific products or customers.
• Production delays and defects because you hired another sales rep or implemented a new marketing campaign without realizing the added production is above your current capacity
• Cash flow issues because a piece of equipment desperately needs replacing but that money is tied up in growing accounts receivable and inventory balances

The lack of forward-looking financial insights means leaving money on the table and risking the long-term health of the business.

So, how can manufacturers move beyond relying on generic financial data? How can you reconfigure your data to make informed, proactive decisions that increase financial performance and provide higher paying jobs for your local community?

The Finance Advantage - Your Roadmap to Profit

By taking your existing financial information, and reorganizing it, you can create a powerful decision-making framework that allows you to improve future performance. Here's a high level view of the 4 core pillars of content we discuss here that helps create a finance advantage:

Pillar 1: Strategic Planning, Budgeting, & Forecasting

Strategic planning is all about setting clear, long-term goals and working backwards to determine the objectives and milestones necessary to achieve those goals.

This involves analyzing the external environment, such as what the broader industry and economy is facing, as well as internal environments, such as competitive advantages. External environments are always changing, whether its new opportunities, changing regulations, and more. Internal environments relate to how your business stacks up to the competition, as well as its financial position. By evaluating both of these environments, you are more informed to formulate, prioritize, and implement various strategies necessary to improve the business, both over the short and long term.

Once strategic planning is established, budgeting is made possible.

Budgets take objectives from the strategic plan for the upcoming fiscal year and organizes it into an order of operations necessary to move the business towards its long-term goals. Budgets create a detailed annual financial roadmap that can be used to measure performance against. Most businesses rarely have a budget. They typically use their financial performance from the prior year to monitor how they are doing. But the conditions from year to year change. Products and customers are added or dropped. New equipment that is more efficient may be purchased. Raw material and labor costs change. This makes year over year comparisons less useful. Budgets on the other hand account for these changes so you're comparing apples to apples.

As the year progresses, forecasting becomes increasingly more important.

The budget relies on a given set of assumptions. These assumptions may deviate from what is actually occurring in the business. For example, an initiative may fall behind schedule. Raw material prices may suddenly increase. Sales may be booming but production is falling behind. Forecasting accounts for these changes when they are material. That way as the year progresses, you will know if you are above or below your budget targets. You can implement different strategies to course correct and hit your targets, as well as prepare for various scenarios.

Pillar 2 - Performance Management

Performance management involves regular monthly reviews to analyze actual results versus expectations.

Thanks to Pillar 1, you will have a budget and/or forecast to compare your actual results to. This can be used to identify opportunities or problems that need to be addressed. When actual results deviate from expectations, you can dig deeper to understand the underlying drivers of these differences and implement changes to improve future performance.

Another component of performance management is the use of Key Performance Indicators (KPIs).

These track the most critical metrics for success. Establishing KPIs requires a mix of leading and lagging indicators. Leading indicators, such as new sales orders, are more readily available for review before lagging indicators, such as revenue, which is only available after the financial reporting period is completed. KPIs must also balance short and long term performance, as well as combine financial metrics with non-financial metrics. Relying solely on financial metrics can fail to highlight issues that will affect future performance. For example, an trend of increasing customer churn will inevitably result in lower financial performance as time progresses.

Pillar 3 - Per Unit Metrics and Competitive Advantages

Unit economics is the profitability of a single unit sold.

Many times the true profitability of these products or customers are hidden within the consolidated financial statements. This makes it difficult to determine which ones are adding to the bottom line and which ones are actually creating losses.

Per unit metrics gives you the view to understand the revenues, costs, and profits for a single unit sold. This can be done on a company wide basis, a specific product, customer, or even a new purchase order. This is crucial for ensuring your production is focused on profitable products and customers.

Unit economics allows for the use of Cost-Volume-Profit (CVP) analysis. This helps show the relationship between pricing, costs, and sales volume and how they affect total profits. Sometimes it is more profitable to increase prices, despite a decrease in sales volume. Other times doing the opposite is more advantageous.

You will need to create competitive advantages in 3 key areas in order to improve unit economics, which in turn improves profits.

1. Cost Advantage
2. Sales & Marketing Advantage
3. Value Advantage

Cost Advantage

Cost management is one of the greatest challenges in managing a manufacturing business.

Looking at total costs compared to prior periods or even to budget or forecast can be misleading. Sales volumes between each of these will be different than actual. If we have a higher sales volume than expected, we should also see variable costs increase. This is why it's important to look at the costs per unit, as it normalizes for differences in volume.

Creating a Cost Advantage is all about finding ways to increase productivity. Productivity is simply how much output do we get for a given input. The higher the output to input ratio, the higher the Cost Advantage. This is how you can beat competition from foreign producers. While they may have cheaper labor, raw materials, or conversion costs as measured in absolute costs, such as cost per labor hour, you can still be more cost effective in terms of cost per unit by increasing productivity.

In order to increase productivity, we need to focus on improving 3 key areas:

1. Systems & Processes
2. Technology
3. People & Talent

Systems & Processes focuses on improving how things are done in operations and the wider business. Technology augments your employees' productivity through the use of machinery and software. People & Talent focuses on hiring great employees from the get go, and getting them up to speed as quickly as possible to become productive in the business with training, and providing opportunities for advancement.

Sales & Marketing Advantage

Creating a Sales & Marketing Advantage is another powerful competitive advantage.

It allows you to acquire and retain customers with ease. This comes down to focusing on 3 key areas:

1. Generating Quality Leads
2. Converting Leads into Customers
3. Retaining Customers

Improving each of these has a compounding effect. If we double our quality lead generation from 100 to 200, we double our number of leads converted to customers. If we then double our lead to customer conversion numbers, from say 5% to 10%, we would 4x the number of new customers we generate (5 new customers at 100 quality leads and 5% conversion ratio vs 20 new customers at 200 quality leads at 10% conversion ratio). If we improve the customer retention rate, the compounding effect of acquiring and retaining new customers sky rockets.

Value Advantage

The final competitive advantage is the Value Advantage.

Value is the perceived benefit a customer gains from a product relative to its cost, compared to available alternatives. The goal is to produce products in a way that increases the value to cost ratio for the customer. This way, your product will have the highest value to cost ratio compared to alternatives available to the customer, which means the customer inevitably chooses your product.

Creating a value advantage requires optimizing the business to produce products that have the traits deemed most valuable by a specific group of buyers. The higher the value advantage, the higher pricing power your business has.

Value advantages are created by focusing on 3 areas:

1. Market
2. Experience & Quality
3. Product

Market focuses on a specific customer group. Different customer groups have different purchasing power. Simply focusing on the right customer group can increase profits as those customers are willing to pay a premium for the same exact products.

Experience is the customer's interaction with the business. This comes down to making it easy to do business with you. It can be something as simple as progress reporting to let your customer know when to expect the delivery of their order or reducing the time it takes from initial purchase to delivery of the final product, etc.

Quality is reducing product defects and producing products that are durable and reliable to meet customer requirements.

The final area of the value advantage is product.

What products you manufacture determine value potential. The same raw material can be used to create different products with vastly different pricing and profit potential. For example, corn as a raw material can be used to produce ethanol or it can be used to create bioplastics. Choosing to manufacture the higher value added product will result in higher pricing and profit potential despite starting with the same raw material.

Manufacturers can use the same production process to produce different products by simply changing the raw material input. A good example of this is a plastic injection molding company. A low margin option is to produce plastic based children's toys while a higher margin option would be to produce plastic for medical uses. The production process is the same but the raw material input requirements may be different. Plastic for medical uses commands a far higher premium than children's toys would.

The 3 competitive advantages work together to increase value (Value Advantage), get in front of potential buyers and show them how your product is more valuable than their alternatives (Sales & Marketing Advantage), and produce those products in a cost effective way so you can charge a price that maximizes profits (Cost Advantage).

Pillar 4 - Capital Management

The final pillar of a strategic finance function is Capital Management.

There are 3 key areas of Capital Management:

1. Cash Flow
2. Investment Decisions
3. Risk Management

Cash Flow

Ensuring cash flow growth is the number 1 priority in any business.

Manufacturers often face cash flow issues. A lot of cash can be tied up in working capital. Accounts receivable and inventory are the two biggest areas where balances increase while the business begins production and subsequently awaits customer payment. In the meantime, the bills have to be paid. This becomes increasingly difficult during growth periods. Without proper cash flow management, you will not be able to balance growth with stability. You could ultimately run out of cash even though your profits are high but cash inflow is lagging behind cash outflows.

Investment Decisions

New investments are always required to stay in business.

Whether it's replacing old, worn or outdated equipment, or expanding facilities, all of these are significant investments that require careful planning to ensure money is being spent on the areas that will generate the highest return on investment, both in the short and long term.

A process is needed to evaluate a variety of investment opportunities. These opportunities must be prioritized based on the ones that show the most promise while balancing any financial and operational constraints. We can't pursue all investment options simultaneously. We either don't have enough money to do so, or don't have enough manpower to execute those investments. Only a few investments will meet the variety of constraints currently facing the business.

Risk Management

At the same time, some of these investments riskier than others.

For example, expanding existing production processes to fulfill more volume is a safer bet than investing in an entirely new product production line. One is simply selling more of what has been previously done. The other is selling a new product that has zero historical data as to whether it will pan out or not. The upside of each of these may also be different. The former may have a lower upside potential, but the latter may sky rocket performance.

Risk management helps evaluate these investments based on their potential upside compared to the likelihood of achieving that upside. Every business should make some risky investments that have huge upside potential. But focusing solely on these investments can lead to the downfall of the business. Focusing on the right mix of safe, low return investments with risky, high return investments helps ensure the business is able to increase its future financial performance year after year, even if those risky investments don't pan out.

Creating Thriving County Capital Cities and Surrounding Rural Areas

The goal of Productive Powers is to arm manufacturers with the business finance skillset required to increase future financial performance, expand and hire more local employees, and ultimately help their communities thrive.

We've seen how devastating it is when manufacturers leave a given area. It creates a doom loop. Jobs are eliminated. Wages fall. Tax revenues fall. Maintenance is deferred. The town deteriorates. The community's youth leaves for opportunities elsewhere. The town is not longer what it used to be.

Manufacturers play a key role in bringing money into their local community. They've done it before, they can do it again. Productive Powers is all about ensuring these manufacturers have the business finance skillset required to thrive in this local areas.