Five Lessons Manufacturers Learned in 2020

Date December 29, 2020
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As the new year approaches, we are eager to put 2020 and its challenges behind us and embrace a hopefully much improved 2021. Manufacturers are no different; whether experiencing struggles or business growth in 2020, most manufacturers are anxious to begin the new year. However, before we put 2020 in the past, consider five lessons that manufacturers learned – or were reminded of – in the past year:

  • A strong balance sheet can help you weather challenging times. Cash is king. That’s an unalterable principle, but one that took on even more importance in 2020. Having enough cash or cash availability to weather a storm proved vital to ongoing operations, if not survival itself. Government loans and grants supported many manufacturers, but overleveraged companies (or those with a high amount of debt) now find themselves in an unexpected position. Many are working actively to determine how to reduce debt in times of continuing uncertainty, while others face struggles and lender pressures to resolve the debt, as restrictions to capital have become increasingly common.

    Lesson: Actively work on improving your balance sheet in good times to be able to persevere through tough times.

  • Relationships are key.

    Technology has been a boon to manufacturing, but in an age of technology and automation, some manufacturers have found that their face-to-face relationships have weakened or have been replaced by email, text messages, and automated communications. Although many relationships may remain more virtual than in the past for some time, virtual technologies such as video calls can create a pseudo-face-to-face environment while reducing the time and cost associated with travel.

Using all available methods to proactively build and maintain relationships will help manufacturers through uniquely challenging issues that have emerged in the pandemic. Think about the benefits of these relationships, including:

  • Relationships with customers can aid in your understanding of their needs, allowing you to anticipate their future needs and make efforts to supply them without disruption.
  • Relationships with vendors can help you ensure your own supply chain continuity by understanding potential problems and seeking alternatives, when necessary.
  • Relationships with advisors can help you decipher complex COVID-19 regulations and maximize available loans, grants, and tax deductions or credits available.
  • Lesson: Look for ways to continue relationships in safe, meaningful ways, including through virtual technologies that can actually help us save time and money.

  • Diversification and flexibility can build resiliency.
  • Firms with a diversified customer base were better equipped to navigate the pandemic economy. Even in non-pandemic times, having a handful of large customers or a focus on one end-user market created risk, especially if those customers or if that market faced a business downturn. Further, the pandemic caused markets previously identified as growth markets, such as aerospace, to falter, while some commodity markets, such as consumable products including disposable kitchenware, surged.

    Some manufacturers took their diversification a step further and retrofitted their operations to support needs created by the pandemic, such as for personal protective equipment (PPE). They supported their communities while protecting their income by adjusting their operations quickly to respond to immediate demand.

    Lesson: While focusing on commodity products and exploring rapid retrofits may never be key parts of your strategic plan, the ability to recognize and adapt to customer needs and diversify your customer base can help strengthen your business, especially in weak economic times.

  • The lowest cost might not be the best option.
  • Many manufacturers work with overseas suppliers to deliver critical products at low costs. However, after some tariffs were implemented, efforts to re-shore (or resource those goods domestically) increased. For those still working with overseas suppliers, disruptions caused by the pandemic and related international shutdowns created ongoing supply chain questions and resurfaced calls for the re-shoring of critical goods

    A manufacturer’s supply chain strategy should consider cost, quality, and the potential for disruption. Even firms relying principally on domestic supply chains should have multiple alternate sources for critical supplies or materials before a problem occurs.

    As the supply chain is critical to a manufacturer’s ability to supply, a manufacturer should carefully outline its supply chain strategy. Think about the supply chain similar to a succession plan or an IT continuity plan. A problem can occur that interrupts the ability to do business; what can we do to ensure that those interruptions are mitigated?

    Lesson: Manufacturers should plan for supply chain continuity for equipment, supplies, and other inputs needed to manufacture their products.

  • We can be optimistic about 2021 and beyond.
  • While there remains uncertainty about how the pandemic will continue to affect us in 2021, there are many reasons to have cautious optimism about the year ahead. First, as additional federal COVID-19 relief programs have been passed into law, manufacturers may find new support options available to them, including a second draw Paycheck Protection Program loan, extended and expanded Employee Retention Credit, or tax credits or deductions. In addition, some states and localities have other programs that can support manufacturers, such as Ohio’s TechCred program. As always, manufacturers should carefully evaluate their eligibility for any programs available and carefully assess those that can support them.

    As more people are vaccinated against COVID-19, the stress on our overall economy is anticipated to decline. Further, business opportunities may increase as additional reshoring efforts could result in more domestic production. Advanced technologies, such as robotics, artificial intelligence, additive manufacturing, data analytics, and cloud computing, will continue to make operating more efficient and level the competitive playing field.

    Lastly, while manufacturers faced pre-pandemic challenges of available workers, the higher level of unemployment has more potential workers looking for their next opportunity. Manufacturers looking to expand their workforce may want to actively consider their recruiting and training strategy to support their business needs while also aiding those in need of employment. Lesson: Manufacturers planning for 2021 should have cautious optimism, considering multiple economic and healthcare factors that could contribute to a year of recovery and opportunity.

    Most economic analysts expect slow but steady economic growth in 2021. It should be a year of recovery and a chance to move our companies profitably forward. The lessons we learned from 2020 will help us prepare for better times in the coming year and beyond.

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WIP: A Critical Management Tool

Date February 4, 2020
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A common investment disclaimer reads, “Past performance is not a guarantee of future results.” The same applies to the world of construction. Annual and interim financial statements provide valuable information about a contractor’s past performance and current financial strength, but offer little clarity when it comes to what investors and lenders can expect going forward. That is why so many users of a contractor’s financial statements spend more time analyzing the company’s work-in-progress (WIP) schedule than they do their prior year’s income statement. There is a wealth of information buried in WIP reports that can be as beneficial to the contractor as those looking to invest in or provide financing for a project. This tool has proven itself critical to those who supply credit to a contractor (be it their surety or bank), so why do so many contractors fail to use it to run their businesses?

How WIP Works and What It Means

Under generally accepted accounting principles (U.S. GAAP), except in certain limited cases, contractors must recognize revenue on long-term contracts under the percentage-of-completion method. Under this method, revenue is recognized relative to progress toward completion of a job. For example, if a contractor has incurred 50 percent of their total costs on a project, they are able to recognize an equal percentage of the contract price on that job as revenue, regardless of how much they have billed or collected. The amount billed to date, over or under revenue recognized, is either a contract asset (underbillings) or contract liability (overbillings) and is reflected as such on the company balance sheet.

If a company has a large amount of underbillings, this can be a red flag for sureties and bankers, who may interpret them as potential future losses. It should also be a warning sign for the chief financial officer, controller and project managers before these figures are ever released to outside parties. Are these an indication of poor project management, delays in the billing process, or a need to update projected total costs on a job? Perhaps there are unapproved change orders for which work has begun or there are significant material costs that are not billable until installed. Each job can have its own unique situation that creates an underbilled scenario, so it is important to evaluate each job individually. Management should be prepared to explain underbillings and their cause while also being able to determine the proper response to correct any operational deficiencies that may have contributed to them.

Overbillings are generally viewed more favorably by creditors, as they are a way to have the customer finance the completion of the project. However, there are also some concerns to be aware of when it comes to overbillings. A WIP schedule with a combination of jobs with losses and jobs with large overbillings can indicate trouble ahead. In such a case, the billings from one project are essentially being used to cover the costs of other projects. This will create a squeeze on cash flow as the overbilled projects progress, the overbilling recedes, and cash received from one job is used to finance the completion of another. Think of it as a Ponzi scheme playing out in the financial statements. That is how creditors view it.

Overly Optimistic?

Lenders and surety bonding companies also focus on projected gross profit percentages for individual jobs. Are there any that look out of place given the contractor’s previous performance? Some contractors are eternal optimists and always project a best-case scenario when it comes to performance. If a contractor’s completed job schedule reports average profit margins of 20 percent, the lenders and sureties are certain to take a close look at jobs in progress that are projecting a gross profit of 25 percent or more. Contractors should ask themselves the same question and be able to explain why current jobs will outperform historical margins. Is there something different about this job that lends credence to the elevated gross profit percentage, or should we take a closer look at the cost to complete it? “Profit fade” is a term used to describe when gross profit from a contract is less than previously anticipated. Profit fade resulting from overly optimistic projections at an interim date will erode a creditor’s confidence in a contractor’s ability to estimate their job costs accurately. This in turn will result in reduced credit and lower bonding capacity for a contractor.

Monthly Job Reviews

A WIP schedule that is kept up on a monthly basis can be a great tool for measuring job performance. Of course, like any tool, it is only as good as the information that is put into it. If actual and estimated job costs are not correct, the report will be inaccurate and misleading, and the contractor will look incompetent in front of their surety and banker. Conversely, if monitored closely, warning signs, spotted early on, can help get a job back on track and avoid continued losses. The better a contractor becomes at monitoring their jobs in this fashion, the better they will be at preventing profit fade and demonstrating themselves as a skilled, knowledgeable and financially savvy player in the construction industry. Contact a member of HBK’s Construction Solutions Group for additional resources.

Original article published in The Dirt, Magazine.

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