Many manufacturing companies are looking for new ways to reduce costs and enhance profitability. For some this means upgrading equipment or streamlining processes while others focus on new customer acquisition, existing client satisfaction, technology upgrades and expanding staff skills. While each company has their individual challenges, there are also industry-wide pressures that consume management’s attention such as globalization, rising costs of benefits and changing government regulations. It’s obvious the need to continually adapt and grow is essential for success. Therefore, how can a company measure its progress towards reaching its growth and cost reduction goals? You may be surprised to learn that using financial ratios with information found in the company’s financial statement can provide essential insights. To help clients, prospects and others understand these ratios and the information they can provide, Barnes Dennig has provided a summary of the most valuable ones for manufacturing companies below.
Key Manufacturing Financial Ratios
- Manufacturing Costs to Total Expenses – When looking to manage or reduce costs it’s important to understand how much of total expenses are being driven by manufacturing costs as opposed to other operating expenses. This helps management understand if rising or decreasing costs are coming from efficiencies in the production process or changes in expenses such as rent, salaries, etc. The higher the number the greater the company’s overall costs are coming from manufacturing.
- Maintenance Costs to Total Expenses – When evaluating company expenses, it’s also important to understand how costs for the maintenance of machinery and other means of production are impacting overall expenses. A low number indicates the company has minimal expenses in maintaining the machinery needed in the production process. This reflects the fact that a company has recently made upgrades and/or replaced machinery or uses machinery that don’t require a high level of maintenance. This ratio helps management and others understand how effectively they are managing maintenance costs as well as when replacement or upgrades may be needed.
- Inventory Turnover – This ratio measures the effectiveness of a company’s manufacturing process. To make this calculation, divide the cost of goods sold by the average balance in inventory. A low number indicates that a company is ordering and keeping more inventory than is necessary for current production needs. When there is too much inventory a company is at risk of waste or having inventory become obsolete before it can be used. A high number may indicate that a company is operating too lean and not ordering enough inventory to meet current demand. It also indicates the company is doing a good job of ordering and consuming the inventory needed for current production demands.
- Total Manufacturing Cost Per Unit – To ensure a company is properly pricing their products and generating the right profit, it’s essential to understand the total costs involved in manufacturing a specific unit. To make this calculation, divide the total cost of manufacturing by the total number of units produced. This calculation can be made for any period or job run, but is most commonly calculated for a month, quarter or period. The result will indicate whether the projected cost for a period per unit was accurate, higher or lower. Management can make necessary adjustments to pricing to have the most favorable impact.
- Productivity in Revenue Per Employee – This ratio measures the amount of revenue that is generated by a manufacturing company, plant or division. The result can help management and owners understand the changes needed (if any) for workforce optimization. To make this calculation, divide the total revenue (company, plant or division) by the total number of employees. Ideally a company wants the highest possible revenue amount per employee.
The information unlocked by financial ratios can provide essential insights into a company’s vitality and effectiveness of growth/cost cutting plans. Because there are critical differences between those within the same industry such as manufacturing, it’s important to compare a company against similar companies.
If you have questions about financial ratios, benchmarking or need assistance with a manufacturing tax, accounting or audit issue, Barnes Dennig can help. For additional information please call us at (513) 241-8313 or click here to contact us.
You can also request a copy of our Manufacturers Compensation, Benefits and Benchmarking Report here.